I’ve posted Entry #150 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Is It Better to Assume That Stock Returns Are Predictable or That They Are Not?
Juicy Excerpt: If we assume predictability in cases in which the evidence is not absolutely persuasive and it turns out that we were wrong to do so, it’s hard to see how much harm would come of the mistake. Investors who believe that returns are predicable will lower their stock allocations once prices rise to very high levels, thereby pulling them back to earth a bit. Is that such a terrible thing to see happen? It sure does not seem so to me. I view price stability as a good thing.
But consider what happens if it turns out that prices truly are highly predictable and yet we cling to an assumption that they are not. Prices will rise and rise and rise and rise until they reach the sorts of levels that applied in the late 1990s and then they will crash hard. The highest P/E10 level we ever experienced prior to the 1990s was the “33” that applied late in 1929 and that brought on the Great Depression. In 2000, the P/E10 rose to 44. In the event that our default belief turns out to have been wrong, the mistake is likely to cause a depression of far greater length and depth than the one we experienced in the 1930s and early 1940s.