“We Were at 3x in 2000. We Will Be at 0.5x When This Is Over. That’s a Loss for Every Stock Investor of Five-Sixths of His Accumulated Wealth of a Lifetime.”

I have been contacting numerous people to let them know about my article on The Silencing of Academic Researcher Wade Pfau by the Buy-and-Hold Mafia.

Yesterday’s blog entry reported on my correspondence with Economics Professor Valeriy Zakamulin. Set forth below is the text of my response to the e-mail detailed in the earlier blog entry:



I get what you are saying here and I agree with most (but not quite all) of it.
I 100 percent agree that excessive P/E10 values over-correct. That is a hugely important point and one that even many who believe in P/E10 do not get.
The important question (in my mind) is — Why?
I believe that P/E10 is reporting to us the state of investor emotions. In 2000, we were insanely in love with stocks. So the nominal price at the time was at three times the true and lasting value (let’s call it 3x). The REASON why prices always over-correct is that the drop from 3x to x is emotionally devastating. The drop from 3x to x causes a loss of $12 trillion of buying power in our economy. That loss causes tens of thousands of businesses to fold and puts millions of employees out of work. The economic destruction causes us all to lose hope for the future. Our despair causes us to lose hope that stock prices will ever recover. So the P/E10 value falls not to fair-value (15) but to one-half of fair value (7 or 8). There has never been an exception to this rule. Every secular bull market has produced a secular bear market that put us at 7 or 8.
Please consider what this means in the current context. We were at 3x in 2000. We will be at 0.5x when this is over. That’s a loss for every stock investor of five-sixths of his accumulated wealth of a lifetime (assuming a 100 percent stock allocation — you need to lower the loss to reflect the percentage of a portfolio not in stocks in 2000). This is why it is so imperative that we get word out re all this. To get to a P/E10 of 7 would take another 65 percent price drop over the next few years. That would put us in the Second Great Depression.
But this is 100 percent optional Great Depression! A P/E10 of 7 is as insane as a P/E10 of 44. If we tell people how stock investing works, we will never see such extreme P/E10 values again. Once we get the word out, stock prices become self-regulating. If people understand that they MUST change their stock allocations in response to big price swings, each swing upward will bring on sales and those sales will pull prices back to fair-value levels again. There can never be another bull market or another bear market once we permit open discussion of Shiller’s findings. We want people to invest in a rational way. But people cannot be rational without easy access to good information and the idea that is constantly pushed that timing is in some way a bad thing causes those who understand how important long-term timing is to keep their mouths shut about it. So investors do not today have access to the information they need to make intelligent choices.
Stock prices cannot be precisely predicted at ANY P/E10 level. That is because prices are determined by emotion in the short term (up to ten years) and by economic realities in the long-term (over 10 years). The price that applies at any given time is a combination of short-term and long-term effects. Long-term prices are to a large extent predictable but not fully so because prices are always at least to some extent influenced by the investor emotion that applies at the moment and this is never predictable at all (emotion is irrational and thus cannot be predicted). Some people say that the r-sqaured for P/E10 does not show a large enough correlation. It shows the precise amount of correlation that we should expect if the Shiller model is accurate! We should not expect a perfect correlation because Shiller says that emotion affects prices in the short term and so the short-term aspect of any price should never be predictable. The market behaves exactly as we would expect it to behave in a world in which Shiller’s understanding of how the market works is the right one.
The right way to think about this (in my view!) is that P/E10 tells you the extent of risk in the market. It never identifies the precise return that will apply in 10 years. It always identifies the range of possible returns (the range is 6 points in either direction — when prices are at fair-value levels, the range is from an annualized 10-year return of 0 on the down side to an annualized return of 12 percent real on the up side) and assigns rough probabilities to an actual outcome falling at any point on the range of possibilities (the most likely 10-year outcome starting from a time of fair-value prices is an annualized return of 6 percent real).
People have a hard time relating to this because we are all accustomed to focusing on the short-term, what will happen in the next year or so. The Buy-and-Holders showed that that is a waste of time (I believe they are right that short-term timing never works and I believe that this was a major advance). What the Buy-and-Holders missed is that long-term outcomes are nothing at all like short-term outcomes. Long-term outcomes are HIGHLY predictable. Buy-and-Holders advise against all forms of timing because they believe that risk is stable and thus the best bet is to maintain a constant allocation. Valuation-Informed Indexers believe that risk is variable and that the key strategy imperative is to keep one’s personal risk profile constant and this REQUIRES long-term timing. If long-term timing works, staying at the same allocation at all times is an insanely risky choice. It is ALWAYS going to produce a wipeout sooner or later. And, indeed, in the historical record we see just this. Those who remain at a high stock allocation ALWAYS experience at least one wipeout at some point in their investing lifetimes (which delays their retirements by years or in some cases by decades).
A fair-value P/E10 on the way up is a very different thing than a fair-value P/E10 on the way down. It’s not the number alone that matters. You need to take into consideration what CAUSES the fair-value P/E10 number. A fair-value P/E10 on the way up is caused by POSITIVE investor emotions — people are getting over the panic they felt during the preceding crash and slowly gaining confidence in the stock market again. A fair-value P/E10 on the way down is caused by NEGATIVE investor emotions — people are terror-struck at the prospect of losing all their money but not able yet to fully process the damage they did to their portfolios by following Buy-and-Hold strategies during a bull market.
One of Shiller’s most important lessons is that stock investing is NOT purely a numbers exercise. We can use numbers to generate insights. But the numbers must always be considered in light of the reality that investing is done by humans, who are emotional creatures. Strictly numbers-based analyses leave out an important part of the equation. This is why much of the research in this field has gotten off track (n my view!).
Thanks again for the stimulating back-and-forth and for caring enough to at least take a look at some of my thoughts re these matters.


  1. The Pink Unicorn says

    Rob is praying for a crash so that other people will be as broke as he is.

  2. Rob says

    That’s an emotional comment, Pink.

    Investors are better off knowing when stocks are priced to crash. My peer-reviewed research shows that knowing this reduces the risk of stock investing by 70 percent. Good stuff.

    So why don’t the “experts” tell you when stocks are priced to crash?

    The thing they are expert in is getting money out of your pockets and into theirs.

    If you don’t know when stocks are priced to crash, you are left with no option but to go with a high stock allocation at all times. Guess which asset class puts the most money in the pockets of the Wall Street Con Men?

    Some of this investing stuff is so darn hard to figure out!


  3. The Pink Unicorn says


    I am just reporting what I see.

    Since you know when the markets crash, you must be filthy rich by now. Why not give us an update on your current financial net worth.

  4. Rob says

    Again, the comment is emotional.

    Knowing that price discipline is required in stock investing does not make one “filthy rich.”

    What it does is make one sensible.

    Is everyone who considers price when buying a car “filthy rich”?

    By no stretch! But those who consider price when buying cars certainly should be thought of as smarter consumers than those who fail to do so.

    So it is with stocks.

    The people who sell stocks love it when they can persuade you that a Buy-and-Hold strategy can work. Oh, Buy-and-Hold works! For them!

    It NEVER works for those buying stocks. Never once in the 140 years of history we have available to us has this ever happened.

    I invest for ME, Pink. I figure that the Wall Street Con Men can take care of themselves.


  5. Rob says

    I’d rather be rich than Rob’s definition of ‘sensible’.

    I certainly wish you the best of luck with it, What.


  6. The Pink Unicorn says

    Rob says:

    “I invest for ME, Pink.”

    Okay Rob. So when you invest for “ME”, how has that worked out for you? Certainly, you must have amassed such a large fortune since you are able to time the market so perfectly and the rest of us are “hurting”. I am doing very well at the moment in my “hurting” condition. That must mean you have a financial net worth in the stratosphere since you are such an investing expert and can time the market so perfectly.

  7. Rob says

    Your comment is filled with emotion, Pink.

    And it is NEGATIVE emotion.

    Please go through it and identify all the stuff that is holding you back.

    That will bring on a liberating feeling.

    When you have stopped holding yourself back, you will be free to run forward and even to fly, using the peer-reviewed academic research of the past 32 years as your guide.

    I hope you are able to relax enough to “get it” and take off, my old friend.


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