Valuation-Informed Indexing #180 — Should We Assume That Stock Prices Are Predictable If There Is No Evidence Otherwise?

I have posted Entry #180 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s titled Should We Assume That Stock Prices Are Predictable If There Is No Evidence Otherwise?

Juicy Excerpt: Markets depend on price discipline to function. It is because the person buying a car is trying to push the sales price down while the person selling the car is trying to push the sales price up that the car market is able to do a good job at setting the prices of cars roughly where they should be. When large numbers of investors come to believe that Buy-and-Hold strategies can work, price discipline disappears from the stock market and the market becomes dysfunctional. Eventually, prices rise so far from where they would be if market participants were practicing price discipline that the only way the market can continue to function is for prices to crash.

That all follows, doesn’t it?

I believe that it is this failure to research long-term timing that explains why two people as smart as Eugene Fama and Robert Shiller could come to opposite conclusions on the question of how stock investing works. Fama concluded that the market is efficient before Shiller published his research showing that long-term timing always works. Fama has tuned out Shiller’s findings for 32 years now because in his mind timing is out of the question. Had Shiller published his findings first, Fama would have put his mental energies to the task of developing a model to explain how stock investing works with the thought that price discipline is essential firmly established. Because of a quirk of historical timing, he instead came to the project with an entirely inappropriate hostility to research-based showings of the importance of one form of market timing.

Comments

  1. Anonymous says

    Buying stock is not like buying a car or bananas. Stock is not consumed and it is not a mass produced item. Instead, it is a productive asset that can grow as the economy expands and or new markets are created.

  2. Rob says

    I don’t agree with what you are saying here, Anonymous.

    The thing you buy when you buy shares in a broad index fund is a tiny portion of the productivity of the U.S. economy. You are buying an income stream of 6.5 percent real.

    That income stream IS consumed. If you buy $100 worth of it, at the end of 12 months you have an asset worth $106.50. The ability of that asset to generate wealth for you in the first year of your holding of it has now been consumed. If you want to pretend that on the last day of your first year of ownership of it, it produced 10 percent more income, you can do that. The Wall Street Con Men will encourage the fantasy because they make money when people come to believe in it. But it is not so. That asset can only produce so much income in a year for its owner (and for 140 years, that amount has been 6.5 percent real) and pretend games don’t change that.

    But wait! Doesn’t the portfolio statement indicate that the extra 10 percent is real? If you sell the asset at the conclusion of that big up day in its price, won’t you receive the 10 percent fantasy gains (as well as the 6.5 percent real gains) in return?

    Yes, the portfolio statement will show the bigger number. And, yes, the nice people who purchase the shares will pay the higher price and you will receive an amount consistent with the fantasy version of the story.

    So the Pretend Gains are real?

    Not quite.

    They are temporarily real.

    You (and all the owners of all the shares of the same asset class) have borrowed them from future owner of that asset class. Returns greater than 6.5 percent real this year signify returns of less than 6.5 percent in some future year. It’s like with credit cards. With credit cards, you can spend more than you earn in a year. But you have to pay the money back. The amounts you borrowed are not the same as the amounts you earned.

    Fantasy thinking doesn’t work any better with stocks than it does with credit cards. You have to pay the money back. Get real, Anonymous.

    If short-term timing worked, you could play a neat trick. You could always cash out before the Pretend Gains disappeared. But short-term timing doesn’t work (thanks for the breakthrough finding, Eugene!). Given that short-term timing doesn’t work, you are better off not pretending that the phony gains are real. It will just get you into trouble. Heck! If you pretend that the phony gains are real, you might hand in your resignation from a job to begin an early retirement for which you have not saved enough. Imagine the consequences!

    Shares of an index fund are indeed a productive asset, and, yes, the gains they produce are financed by the growth of the economy. All that is so. But the economy is not a perpetual motion machine. Investors decide what value to assign to shares of index funds. Investors are biased. They have Get Rich Quick dreams in their heads. They understand that all they need to do to vote themselves raises is to pretend that their index fund shares have generated more gains than they really have. So they are drawn to Buy-and-Hold strategies that tell them that whatever value they assign to their shares is real. Wouldn’t it be nice if financing a retirement were really as easy as making up a number and getting a bunch of other people who also benefit from pretending that an absurdly high number is real to go along with the fantasy game?

    It is not quite that easy, Anonymous.

    The 6.5 percent return is real. That’s a good deal. Stocks are a super asset class. You shouldn’t complain.

    Anything more than that is fantasy stuff. Not real.

    You should stop pretending. And you should encourage others to stop pretending.

    We have caused millions of failed retirements with these stupid games. We have put millions of people out of work with these stupid games.

    The joke isn’t so funny anymore.

    My sincere take.

    Rob

  3. Anonymous says

    I am not surprised you don’t agree, but you clearly don’t understand. When you buy a car, you use up some of its life when you drive it. Eventually, the car will wear out and you have nothing left. When you buy stock, the company produces earnings and it continues to produce earnings. It doesn’t “wear out”. In fact, it has organic and, often times, inorganic growth. You are comparing apples to oranges.

  4. Rob says

    You also continue to incur a cost. The money that you have invested in stocks could be put to other uses. There is ALWAYS a cost to owning stocks, even long after you have purchased them.

    I am not comparing anything. I am saying that price matters with every good and service you buy, that stocks are not the one magic exception. The idea that you don’t need to consider price when buying stocks is a logical absurdity.

    At what point does Jack Bogle say that stocks are not worth buying? We got to three times fair value in 2000 and he did not say that we had yet reached that price. Would four times fair value do it for him? Ten times fair value? One-hundred times fair value? What would it take?

    Buy-and-Hold posits that price doesn’t matter and so no one bothers to look at price. That’s why we have economic crises. The market wants to get the price right and it can’t do it so long as most investors are refusing to exercise price discipline. Eventually, things get so out of hand that the only way we can ever get back to fair value is with a price crash. But prices crashes take trillions of dollars of spending power out of the economy and thereby bring on economic crises with massive unemployment and all the rest.

    It’s not worth it. There must be SOME price at which stocks are not worth buying. Once we acknowledge that as a society, we will permit discussion of what that price is. That will be the biggest advance in the history of investing analysis. The only thing holding us back today is our unwillingness to talk about the realities.

    I’ve looked at the realities. The realities are positive. There is nothing to be afraid of.

    My take.

    Rob

  5. Anonymous says

    You (and all the owners of all the shares of the same asset class) have borrowed them from future owner of that asset class. Returns greater than 6.5 percent real this year signify returns of less than 6.5 percent in some future year.

    I see. So since Google stock has returned 20% per year for 20 years, it now has to pay back all those gains at some future date?

    Only in your addled mind, Rob. Its price went up because it was successful.

  6. Anonymous says

    There must be SOME price at which stocks are not worth buying.

    Well, obviously. But by definition the price would never reach a level where it was not worth buying, since there would be no buyers.

    Rob, if you ideas had merit, you could state them politely and civilly. You wouldn’t have to become “the most hated man on the internet”.

  7. Rob says

    So since Google stock has returned 20% per year for 20 years, it now has to pay back all those gains at some future date?

    Google isn’t an index fund.

    The prices of the stocks of individual companies can go up by any amount or down by any amount. But the price of an index fund cannot go up or down by any amount. For every company that goes up more than the index fund, there is a company that goes down enough to counter that gain.

    That’s why we have been able to reduce the risk of stock investing now that index funds have been introduced. Indexing is a huge advance.

    Rob

  8. Rob says

    Only in your addled mind, Rob.

    You sound confident of your position, Anonymous.

    Rob

  9. Anonymous says

    “You sound confident of your position, Anonymous.”

    And if you were confident, you wouldn’t have to keep repeating the same things over and over again.

  10. Rob says

    Its price went up because it was successful.

    But that’s not why the price of the broad index fund went up. The price of the broad index fund went up because investors are human and drawn to Get Rich Quick schemes and because the Wall Street Con Men who push Buy-and-Hold “strategies” are happy to exploit that human weakness to turn a quick, smelly buck.

    Not this boy.

    Rob

  11. Rob says

    But by definition the price would never reach a level where it was not worth buying, since there would be no buyers.

    Because all investors are rational.

    Makes sense!

    Rob

  12. Rob says

    Rob, if you ideas had merit, you could state them politely and civilly.

    I couldn’t have been more polite and civil in the way in which I let my friend John Greaney know of the mistake he made in his retirement study. I didn’t even say that I was sure that we should be counting valuations. I put it in the form of a question.

    What Greaney didn’t like is that hundreds of community members quickly saw that I was right. So he responded with his “polite” and “civil” threat to kill my wife and children if I continued to “cross” him.

    That’s science!

    Rob

  13. Rob says

    You wouldn’t have to become “the most hated man on the internet”.

    People’s retirements matter to them. And people don’t like to be played for fools.

    We didn’t discover that there is precisely zero chance that a Buy-and-Hold strategy could ever work for a single long-term investor on the morning of May 13, 2002. Shiller published his peer-reviewed research showing this in 1981. Rather than correct their error, the Wall Street Con Men continued spending millions promoting the pure Get Rich Quick approach for years thereafter.

    Who do you think will be the most hated posters on the internet following the next price crash?

    I have a funny hunch that it might be the individuals who have put up posts in “defense” of Mel Lindauer and John Greaney (and my good friend Jack Bogle?).

    Time will tell the tale, Anonymous.

    My best wishes.

    Rob

  14. Rob says

    And if you were confident, you wouldn’t have to keep repeating the same things over and over again.

    I’m holding all the winning cards, Anonymous.

    Why the heck would I want to stop playing them?

    I’ve got 33 years of peer-reviewed research backing up everything I say. You have zero years of peer-reviewed research backing up what you say.

    That’s the difference between taking the research-based path and taking the Get Rich Quick path. One always leaves you in a good place in the end and one always leaves you stranded in the end.

    You can flip to the winning side any time you choose. But you will be waiting a long time if you are waiting for me to flip to the losing side.

    I mean, come on.

    Rob

  15. Anonymous says

    “I’m holding all the winning cards, Anonymous.”

    No, my actual returns say otherwise

    “Why the heck would I want to stop playing them?”

    You keep repeating things because of lack of confidence.

    “I’ve got 33 years of peer-reviewed research backing up everything I say. You have zero years of peer-reviewed research backing up what you say.”

    I have data going back to the 1920′s which is longer than your 33 years. I also have 2 decades of my own results that are better than your results. In fact, I suspect my cash portion of my net worth probably exceeds your entire net worth.

  16. Rob says

    I suspect my cash portion of my net worth probably exceeds your entire net worth.

    Unfortunately, there are no shopping malls in prison cells, Anonymous.

    It doesn’t look as though I am ever going to get in the swing of this “posting dishonestly about the numbers that my friends use to plan their retirements” thing. Perhaps you’ve noticed.

    It may be that I’ve just seen too many movies showing the sorts of things that happen to people in prison.

    It’s not my particular cup of tea, in any event. That much is for sure.

    But I wish you all the best with it!

    Rob

  17. Anonymous says

    We didn’t discover that there is precisely zero chance that a Buy-and-Hold strategy could ever work

    No we didn’t, and we never will, since it’s worked for approximately millions of people so far, including my now deceased parents. And thousands of Bogleheads report their success with it as well.

    Market’s up 30%, not down 65% since your prediction a year ago. Does the truth hurt?

  18. Anonymous says

    “Unfortunately, there are no shopping malls in prison cells, Anonymous.”

    That is a baseless and silly comment.

  19. Rob says

    No we didn’t, and we never will, since it’s worked for approximately millions of people so far, including my now deceased parents.

    You need to read the Bennett/Pfau research, Anonymous.

    It shows that refusing to exercise price discipline when buying stocks ALWAYS increases risk DRAMATICALLY while also ALWAYS diminishing return DRAMATICALLY. This is only so in the long run. But this has been so in the long run for 140 years out of 140 years. There has never been a single exception. The research was published in a peer-reviewed journal.

    If someone qualified to do research looked at the circumstances that applied for your deceased parents, they would find that they would have done better over the course of their investing lifetimes had they exercised price discipline when buying stocks. That’s a stone cold objective fact. Investors ALWAYS hurt themselves by refusing to exercise price discipline.

    And what would you expect anyway?

    If there were any evidence pointing in the other direction, the Buy-and-Holders would never have put forward a single death threat or a single demand for an unjustified board banning or a single act of defamation or a single threat to get a single academic researcher fired from a single job. Give me a freakin’ break.

    It’s a money-making thing. We all have a Get Rich Quick urge within us and the best way to persuade someone to buy something he shouldn’t buy is to form a strong emotional connection with him. The Buy-and-Holders exploit our emotional weaknesses to the greatest extent possible. It’s no different than when the tobacco companies ran advertisements saying that everyone should smoke to benefit their health. There’s nothing too low for an industry out to turn a quick, smelly buck.

    The rest of us are ashamed that we let it go on for so long. The historical return data is available at Shiller’s web site. We could have checked instead of just following the mumbo jumbo marketing b.s. pumped out by the people trying to persuade us that stocks are the one thing that are worth buying at any possible price. Yeah, sure they are. They were the ones who pushed the Get Rich Quick garbage so recklessly and so ruthlessly and so relentlessly, but we are the ones who fell for the scam. And having done so, we must take partial responsibility for having ruined the lives of millions of our friends and neighbors and co-workers and fellow community members.

    So we are ashamed. We have been taken and we have helped the effort in which millions of our friends were taken and we are deeply ashamed of ourselves for letting this happen.

    Will we work up the courage to stand up for our country in the face of this brutal attack?

    I say we will.

    We’ll find our for sure following the next price crash.

    If we stand up for ourselves and our friends, we will see that we are the luckiest generation of investors ever to walk Planet Earth We are the first that knows (only intellectually today but hopefully in a real and complete sense in the not too distant future) how to reduce the risk of stock investing by 70 percent. There’s that.

    If we don’t work up the courage, we don’t work up the courage. No fair-minded person will say that it was my fault. I’ve put myself out there. I’ve done all that a person can do. I can stand before my Maker and say that without fear of being contradicted. I have a lot of other sins to answer for but I am clean re that one. I was afraid. But I worked through my fears and I stood up and I gave you Goons as good as you dished out and then some more on top of that. Good for me.

    It’s not Get Rich Quick investing strategies that worked for your parents, Anonymous. It’s the U.S. economic and political system that worked for your parents. They made it because THEIR friends and neighbors and co-workers and fellow community members were brave enough to stand up to the threats to our system that came along in THEIR time. Now it is up to us to stand up to the biggest threat to our system that has come along in OUR time.

    If we do it, all is cool.

    If we lack what it takes, that’s a sad end to the story.

    Either way it goes, I know which side I am standing on. I love my country. Call me corny if you must. I love my country. When it comes down to life and death matters, I am there for my country. Even when Goons like you are backed up by Big Shots like my good friend Jack Bogle. I believe that there’s a part of Jack that loves his country and that will cause him to flip when he sees with his own eyes how much human misery his smelly Get Rich Quick garbage has caused millions of people. We’ll see. But either way, I will be standing on the side of the millions of people whose lives have been destroyed with all this abusiveness of the past 12 years, not on the side of the individuals who have seen fit to put up posts in “defense” of Mel Lindauer and John Greaney (a man who acknowledges that everyone who has gotten to know him well describes him as “a complete and total asshole.”)

    It turns out that not only is Get Rich Quick not the answer, Get Rich Quick is actually the problem. Who’d a thunk it?

    Please take good care, my old Goon friend.

    Rob

  20. Rob says

    That is a baseless and silly comment.

    I don’t think so.

    We adopted laws making financial fraud a felony for a reason.

    I only wish we had enforced those laws sooner so that the prison sentences that will be handed out to those who have put up posts in “defense” of Mel Linduaer and John Greaney would have been shorter.

    But it wasn’t my call, you know?

    I DID advance the suggestion.

    More than once.

    And the posts in which I did that are in the Post Archives.

    I did all I could. It was not possible for me to do more and it was not possible for me to do less.

    Rob

  21. Anonymous says

    “We adopted laws making financial fraud a felony for a reason.

    I only wish we had enforced those laws sooner so that the prison sentences that will be handed out to those who have put up posts in “defense” of Mel Linduaer and John Greaney would have been shorter.

    But it wasn’t my call, you know?

    I DID advance the suggestion.

    More than once.”

    Can you list one other person (of any credibility) that believes your claims of fraud and prison.

  22. Rob says

    I have attended three Financial Bloggers Conferences, Anonymous. At each of them I have spoken to a good number of people re the 12-year Campaign of Terror against our board and blog communities led my Mel Linduaer and John Greaney (and my good friend Jack Bogle?). Do you know what the most common reaction has been? The most common reaction has been for people’s jaws to fall open in an expression of complete and total shock.

    That’s not the expression you want to see on the faces of your jury members when the prosecution presents its case, my old friend. I am sure.

    There is no other person who has stated publicly that you are going to prison. That’s not because there are not a lot of people who firmly believe that you should be sent there for a long, long time.

    Wade Pfau tried to do honest work. He objected strongly to Lindauer’s behavior. He didn’t use the word “prison.” He was afraid to. He had seen what Lindauer had done to people who had dared to “cross” him by posting honestly re the dangers of Buy-and-Hold. But it is a very small step from what Wade did say to the word “prison.” The next price crash will take us all forward by the length of that step. Wade will be calling for your imprisonment following the next crash, which is due within the next year or two or three. You know it and I know it.

    And it i obviously not just Wade. There are LOTS of people in this field who long to do honest work. Why the heck do you think Bill Berntein included an entire chapter of his book advocating Valuation-Informed Indexing strategies? He was positioning himself for the post-crash work. He wants to have the popularity and wealth that comes from advocating Get Rich Quick strategies for so long as Get Rich Quick survives while avoiding the prison sentence that follows such behavior for those caught participating in massive acts of financial fraud. Do you think that Bill is going to continue putting forward the Buy-and-Hold b.s. following the next crash? If you think that, I think it would be fair to say that you are more of a fool that I have ever taken you to be, Anonymous.

    And the same is obviously true of people like Jack Bogle and Larry Swedroe and Michael Kitces and Bret Arends and Robert Shiller and Bill Bengen and Carl Richards and Bill Schultheis and on and on and on. None of these people are excited about the idea of going to prison and, in the event that they go to prison, they would prefer that it be for a shorter rather than a longer period of time. So none of these people are going to be putting up posts in “defense” of Mel Linduaer and John Greaney following the next crash. Give me a friggin’ break.

    If you didn’t believe that there was a serious risk that you were going to end up serving a long prison sentence, you would be showing up here every day putting forward your idiotic posts. Who do you think you are fooling?

    If you want my help, you’ve got it. I ask no compensation for it. It’s not a time-senstive offer. If you want my help today, you’ve got it today. If you want my help following the crash, you’ve got it then. Your call.

    I won’t post dishonestly re the numbers that my friends use to plan their retirements. Not in 12 years. Not in 12 billion years.

    Knowing that, you know all that you need to know to know how to proceed in your own best interests.

    If you want to continue putting up idiotic comments while the time in which you could be taking the steps you need to take to reduce the length of your prison sentence ticks away, it’s your call, man.

    You know what I want. But you also know that I don’t control how this goes.

    So you make the call.

    I wish you the best that this life has to offer a person in any event, my old Goon friend.

    Rob

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