Wade Pfau, Associate Professor of Economics at the National Graduate Institute for Policy Studies in Tokyo, Japan, has started a thread at the Bogleheads Forum for discussion of his recent research showing that Valuation-Informed Indexing provides more wealth for 102 of the 110 rolling 30-year periods, while buy-and-hold did better in 8 of the periods.
Juicy Excerpt #1: I know that there is an extensive literature about the predictability of long-term stock returns dating back to Campbell and Shiller’s work in the mid-1990s. I also know that there is an extensive literature about short-term market timing strategies…. But my question is about LONG-TERM market timing strategies. In other words, using market timing over periods of at least 10 years to obtain better returns than a buy and hold strategy. The literature seems slim.
Juicy Excerpt #2: If you have 130 years of data, then that means you have 120 overlapping 10 year periods, or 13 independent 10-year observations. I know 120 overlapping 10-year periods is not the same as 120 independent observations. I’m not comfortable with theoretical statistics, and my intuition may be wrong, but my intuition is that 120 rolling 10-year periods still provides more information than does 13 independent observations.
Juicy Excerpt #3: About Mr. Bogle’s quotation, I have the feeling that he is referring to short-term market timing, right?
Juicy Excerpt #4: What studies show this [that long-term market timing doesn’t work] ? In particular, are there some academic studies that I haven’t found yet? That’s all I want to know. At this point, the two papers by Fisher and Statman do support your view. I already have some concerns about their methodology though, and I am not convinced by their findings. I am looking for other studies that support your view.
Juicy Excerpt #5: Because the precise timing of this mean reversion is not known in advance, and is indeed random, expecting the result to happen in the short-term will not be possible. But long-term investors who can be patient can wait for this mean reversion, while they may lag behind buy-and-holders for years at a time, will eventually come out ahead by the end of the game.
Juicy Excerpt #6: I am quite surprised 30 years produced such good results. I examined 10-year periods and the number of “Lost Decades” were relatively small.
Juicy Excerpt #7: After 10 years, VII is just starting to work.
Juicy Excerpt #8: Since your own work is overtly at odds with the ethos of the board — here, the theme is John Bogle’s philosophy, which eschews market timing, I myself will no longer obliquely support it by giving you a whetstone on which to sharpen your knife. You must certainly know that this very board came into existence in order to ESCAPE the lunatic behaviors of one individual — the very individual with which you have publicly and openly aligned yourself, and who you are openly quoting and sourcing in your column and are forming your intended paper around. While there is much merit in open discussion of competing, differing, and varied approaches, as to you, sir, I personally will have no more of it here on this forum, given the poison well from which you are now openly drawing your own water.
Juicy Excerpt #9: As a relatively new person on this forum, I have no idea what you are talking about. There is someone, not Wade, whose “lunatic” behavior lead to the existence of this board? I can understand avoiding the classic abusive internet behavior of toxic contributors. However, that is a far cry from having no more of open discussion of competing approaches. From what little I have seen on this forum and Wade’s site, I don’t see anything harmful.
Again, I am new here, but I hope people can post ideas that do not conform to others ideas of what Bogle would say. After all, this is finance, not religion. Bogle is a smart guy who has done a tremendous service to American investors, including the majority who do not do business with Vanguard. Does that mean no one is allowed to disagree with him on any topic?
Juicy Excerpt #10: VII switches to 90% only at low P/E10 levels. Which tend to forecast higher future returns. However, keep in mind the reason why P/E10 might have fallen to low levels in the first place: the economic environment was more uncertain than usual.
Juicy Excerpt #11: It was the third case I know of where a new board was created to be just like the old board only without that person. He said he made up the name of his investing system so that people will google it and end up at his site. As far as I have been able to tell, his system is basically his name applied to Shiller’s work and he does not follow the system himself…. Last I read, a newspaper reporter interviewed him and he said he may have to return to work because his website hadn’t taken off.
Juicy Excerpt #12: I believe that there are occasional periods when the broad stock market is overvalued enough that one might choose to reduce exposure or step aside completely. However, I don’t think this long-term timing idea will work well for most investors.
Juicy Excerpt #13: The problem with long-term market timing is it takes too long to find out if your right or wrong.
Juicy Excerpt #14: WHY IS IT SUCH AN ODIOUS VIOLATION OF THE TENETS OF BOGLEHEADISM TO EXPLORE WHETHER SOMEONE WHO HAS ENOUGH PATIENCE AND ENOUGH TIME ON THEIR HANDS MIGHT BE ABLE TO BENEFIT FROM THE TRANSITORY NATURE OF SPECULATIVE RETURNS (I.E. THE IDEA THAT THE P/E RATIO EVENTUALLY ENDS UP WHERE IT STARTED)?
Juicy Excerpt #15: Are you aware of Shiller offering asset allocation advice based on PE10? And other studies like Stein and DeMuth, and the two papers by Fisher and Statman only consider all-or-nothing stocks or bills strategies. If you read Rob Bennett’s stuff carefully, I think he did provide an important contribution in terms of describing a way for PE10 to guide asset allocation for long-term conservative investors. I also think he was right on the issue of safe withdrawal rates. Even if VII ends up being wrong-headed, his heart does seem to be in the right place no matter whatever it is YOU might think about other aspects of his personality.
Juicy Excerpt #16: I think this is long-term timing in the sense that it is based on PE10, and PE10 best predicts what will happen on average over the long term. What PE10 predicts is sometimes inconsistent with current prices, so this is a failure of market efficiency. Given that timing is supposed to be impossible because of market efficiency, the name therefore identifies the fact that the exception to market efficiency requires you to use the long-term.
Having said that, I think we should call PE10 approaches “valuation-based” (or “valuation-informed” or valuation-something) because that’s exactly what they are. This is not to deny that they are “timing”, but it really doesn’t help discussion to use a term that lumps them together with a hundred other ways of varying exposure, which advocates of valuation-based investing would have as little interest in as you presumably do.
Juicy Excerpt #17: Just substitute the lowest equity allocation you’d be comfortable with for his 30% level, the highest one for his 90% level, and the mid-point for his 60%, then you will always have an allocation that’s satisfactory for you, and it doesn’t matter if the timing method fails to add value. If it does, that’s a bonus.
Juicy Excerpt #18: If you look at the top chart, with all the talk of poor market
performance, and all the talk of great depressions, the market
is still relatively expensive. We certainly didn’t put in a 1982 type bottom.
Juicy Excerpt #19: As for his heart being in the right place, honestly I have no idea. At one time he’ll say that God sent him to save the economy and at other times he’ll be talking about how how he quit to make money on the internet and how to get enough page hits to sell ads. I really can’t tell where his heart is.
Juicy Excerpt #20: The data always looks credible in hindsight, the problem is with the real world implementation.
Juicy Excerpt #21: Let me just explain a bit more why I posted about this here. VII has had critics for years, but until Norbert did it in 2008, nobody seemed to have provided a serious investigation of it. I did see a few other investigations, but they just focused on the most recent 20 years or so of data. I just couldn’t understand why. And that bothered me.
Juicy Eexcerpt #22: If you really don’t like market timing in any and all forms, you may not see any point in an empirical investigation. You don’t trust the data to provide proper guidance about how the strategy might work in the future. In that regard, you view me as one of a long line of hucksters trying to sell you some snake oil. I don’t want to be such a person.
Juicy Excerpt #23: Cjking makes an important point. And if I may extend it… if after taking valuations into consideration, you decide that the proper 3 parameters for you are all the same number, then that is okay.
Juicy Excerpt #24: Wade, to be honest, I thought you might be a person who had been lured into spamvertising for a huckster who was banned here. But even if so, I wouldn’t blame you. Personally I’m open to “anything that works”, but whenever someone (not you) tries so so so hard to sell it to me and doesn’t even use it himself, then I get suspicious. I’ve told Rob several times that he is own worst enemy in this respect. He once said “I irritate on purpose. That’s the job.” I don’t think that’s working for him. On the other hand I welcome your explorations.
Juicy Excerpt #25: This strategy brings our the “it’s all backtesting” vitriol like no other . . . and small/value tilters get away without any criticism at all (even though that strategy is pure datamining with no valid economic theory behind it).
I think you have to always consider the issue of macro-consistency: or, what if everyone did it?
If everyone tilted to small/value, then the markets would cease functioning properly. I’m yet to see a Fama French advocate who says, “Well I am very risk-averse, so I’m going to have a significant overweight in large-growth!”
On the other hand, if everyone increased exposure after a market fall and vice versa, then this would dampen out the big swings in the market aggregates, and we might get shallower boom/bust cycles.
I think it’s pretty clear that expected returns are higher the lower markets are valued. There’s the original Campbell/Shiller papers on this, or you can just use some common sense to see that expected returns were surely higher in 2009 than in 1999.
If this is the case, and you can avoid behavioural errors in implementation, then it makes complete sense to have an equity allocation that is in some way flexible. Having a completely inelastic demand for equities is a bit bonkers; no-one acts that way with life’s other important commodities.
In Strategic Asset Allocation, John Campbell advocates a linear valuations-based strategy, so that you wouldn’t be making big changes in allocation (unless the market had moved in a big way), and this would be just like your usual rebalancing strategy but a bit more flexible.
Juicy Excerpt #26: I don’t think anyone really likes market timing in practice – look at the number of people on this board that loaded up on equities in 2009. Zero?
Juicy Excerpt #27: Wade, as you may be aware, John Bogle has mentioned what he calls tactical asset allocation in his book, Common sense on Mutual Funds (pg 66-67). He suggests that it may be used in response to very high stock allocations, with limits of +/- 15%. He also stresses that it should be done very infrequently.
J. Bogle quote: Cautious TA may have a lure for the bold. Full blown TA lures only the fool.
The problem with moving AA based on valuations is if you do it enough, you will be wrong. Not you might be wrong–you will be wrong. The cost of being wrong at 90% equity outweighs the potential reward in my opinion. At 15%, there is damage control.
This quote from Benoit Mandelbrot is relevant: The market is full of almost-patterns.