I’ve posted Entry #296 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called We Have Seen a Four-Year Return of 127 Percent Followed By a 16-Year Return of 29 Percent — But That’s Not Possible!
Juicy Excerpt: There have been two distinct time periods for U.S. investment returns over the past 20 years. For the first four years of that 20-year time-period (January 1996 through January 2000), we saw a total return of 127 percent (this is an inflation-adjusted number, with dividends reinvested). For the latter 16 years (January 2000 through January 2016), we saw a total return of 29 percent.
If you assume that it is economic developments that determine price changes in the stock market, this suggests that the U.S. economy more than doubled over the four-year time-period and then increased by only one-third in the following 16 years, a time period four times greater in length.
Is this even remotely possible? It is not.
There were no economic developments of such great positive power to explain a doubling of the U.S. economy in the years 1996 through 1999. And there were no economic developments of such great negative power to explain why the economy would grow by roughly one-fourth of that amount in a time-period four times longer. These numbers just don’t make sense.
Laugh says
Why do you think there has to ba an instantaneous relationship between market prices and gdp?
I think you start with the wrong premise.
Rob says
That’s not my premise, Laugh. I don’t believe that there is a simultaneous relationship between market prices and economic realities. It is the Buy-and-Holders who believe that. This is the error that they made that has caused all the problems.
In every market that exists, people who buy the product or service look at price before deciding whether to buy or not. This is a universal rule. The lone exception is the stock market. The Buy-and-Holders tell investors that there is no need to consider price when buying stocks. The question is — Is there any justification for this seemingly crazy claim that the Buy-and-Holders make?
There IS a justification. The Buy-and-Holders are not dumb people or bad people. There is a REASON why Buy-and-Holders ignore price. They do it because there was peer-reviewed research published in 1965 showing that timing doesn’t work. To practice price discipline is to engage in long-term timing. The Buy-and-Holders believe that timing is a bad thing because they believe that there is peer-reviewed research showing that timing doesn’t work. They are sincere. But they are wrong.
The reality is that Fama only showed that short-term timing doesn’t work. He never tested long-term timing. It wasn’t even possible to practice long-term timing in 1965 because Bogle had not yet founded Vanguard and index funds were not available (long-term timing only works with index funds). Fama really did show what he tested for and Fama really did show something of great importance — he has been proven right that short-term timing doesn’t work and that was a breakthrough. But Fama obviously did not show that price discipline (long-term timing) is not required or does not work. He never even looked at that question. So his research obviously says nothing re that question.
The first peer-reviewed research looking at the question of whether long-term timing (price discipline) always works and is always required was published by Shiller in 1981. His research showed that price discipline always works and is always required. In hindsight, we can see that it would be preposterous to think that it could have turned out any other way. Price discipline is what makes markets work. All that Shiller showed is that the stock market works the same way as every other market that has ever existed. All of the research done since Shiller’s “revolutionary” (his word) research confirms his finding.
The Buy-and-Holders made a mistake. We need to correct the mistake and move forward. We now for the first time in history know how the stock market works. We need to get the word out. When we do, we will enter the greatest period of economic growth in our history. Everyone benefits. This is a win/win/win/win/win.
The problem in 1981 was that the Buy-and-Holders were embarrassed to have been discovered to have made a mistake. Instead of acknowledging the mistake, they covered it up. The cover-up has caused the biggest economic crisis in our history. Millions of middle-class lives have been ruined. Even confidence in our political system has been undermined. A good number of Buy-and-Holders will be going to prison following the next price crash because of their involvement in this massive act of financial fraud. That obviously includes you, Laugh.
My job (and the job of all of us who love our country) is to EXPOSE the massive act of financial fraud. I don’t say that you will be going to prison following the next price crash because of some personal dislike of you. I am the best friend you have in the world. I am trying to shorten your prison sentence. The sooner you come clean, the fewer lives you will destroy and, the fewer lives you destroy, the shorter your prison sentence will be. That’s just common sense.
If I had a time machine, I would take us back to the morning of May 13, 2002, and we could all enjoy a do-over. I have zero doubt that you would go along, knowing now what you did not know then.
But I don’t have a time machine. Neither do you. Neither does Bogle. Neither does Shiller. So we will have to let it play out this other way instead.
I wil do all that I can to keep your prison sentence as short as possible. That is my pledge to you, my long-time Goon friend. Another way of saying it is that I will do all in my power to EXPOSE this massive act of financial fraud as quickly as it can possibly be exposed. I have for 14 years now been working it as hard as a human being can work it. I will continue to do so. I can do no more and I can do no less.
I naturally wish you all the best that this life has to offer a person.
Hang in there, man.
Rob