I’ve posted Entry #328 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called The Jump in Stock Prices Following Trump’s Victory Could Be a Bad Sign.
Juicy Excerpt: My concern is over the question of why investors are reacting to Trump’s election in the way they are. A Buy-and-Holder would say that it is because they expect to see tax cuts or a huge bill that will produce jobs and spending and profits. But someone who believes that price changes are caused by shifts in investor emotion sees something different in this investor reaction. I see investors who are fearful that a crash is coming and who are trying to quiet those fears and who are generating optimism about the economic effects of Trump’s election as a means to do so.
Stock prices were insanely high in 1996. It would have been correct (in my view) to conclude from that that stocks were dangerous. However, it would not have been correct to conclude that stock prices would fall hard in 1997. As we saw, stock prices soared in 1997 and in 1998 too and in 1999 as well. A natural human reaction in times of desperation is to embrace the thing that is causing the fear that cannot be acknowledged. An alcoholic drinks harder to prove to himself that he has things under control. A man close to losing his job becomes more outspoken in criticism of his boss to persuade himself and those within hearing distance that he is sure that all is well.
Are we bidding up stock prices because we think that Trump is going to take the economy to a good place? Or are we fearful that the time to pay the piper for the phony profits of the past 20 years has finally arrived and feeling a need to convince ourselves otherwise with one final high-valuations fling?
Anonymous says
You also predicted a stock crash during Obama’s last election. How did that work out for you?
Rob says
You have asked this one more than 100 times before, Anonymous.
My answer is always the same. Yes, I predicted that we would see a second crash during Obama’s time in office. No, it did not happen. That’s a point for your side. But it is not a big point for your side.
At the time I made the prediction, I noted that short-term (less than 10-year) predictions) are not based on anything real. All of the peer-reviewed research available to us shows that they do not work; they are sometimes right because guesses are something right, but that’s all they are. So I took a guess and it failed. Is that a big deal?
The showing that valuations affect long-term returns is something very different. That’s a finding that valuations are real, that prices are not determined by economic developments (which are something lasting) but by investor emotions (which can change in a day and cause swings for no good reason). I don’t like having my retirement riding on something transitory like investor emotion. I want to know the real, true, lasting value of my retirement savings so that I can plan effectively for my financial future.
That’s why I adjust my portfolio value for the effect of valuations. That’s why I include an adjustment for the valuation level that applies at the time the retirement begins when I calculate the safe withdrawal rate. I like to get those numbers right.
That’s the deal.
Rob
laugh says
But you are also wrong on the 20 year prediction.
Rob says
That’s a false statement, Laugh.
The return data is there for the examination of anyone who cares to examine it, Laugh. Stocks have performed poorly for the past 20 years when the risk associated with owning them is considered. For the past 17 years, they have just flat-out performed poorly. But even for the past 20 years the story is not good for stocks when risk is taken into consideration.
Do people recognize that? They do not. Most people believe in some version of the Buy-and-Hold story. People believe that stocks go up and stocks go down and there’s nothing that you can do about it. People look at the 17 years of poor performance or the 20 years of not-great performance and they tell themselves “it’s just something you can to live with it, it comes with owning stocks and no one can do without stocks over the long term.” They are wrong to see it that way. When stocks are insanely overpriced, the long-term value proposition is poor. But people have an inclination to rationalize decisions they have made and most of us have gone with some form of Buy-and-Hold strategy and so we tell ourselves things like that as part of the rationalization process.
But is that going to remain the case following the next price crash? I sure don’t think so. I think that people are going to be very upset that their retirement hopes have been crushed and the are going to be looking for someone to blame.And this site tells the story of where the blame lies. Had the Buy-and-Holders permitted honest posting, all of us would have known about the better way, the first true research-based strategy, Valuation-Informed Indexing.
That’s what I believe. You say you don’t believe it. But I notice that you post here almost daily. So it would be fair to say that I have my doubts about the honesty of some of your statements. It could be that you lie to yourself before you lie to the rest of us. In fact, I believe that that is very probably the case. But your story does not add up in my eyes. You have a right to your opinion. And it would be a mistake to tune you out entirely because I can get caught up in rationalizations too and I very much have a bias re this one. But I personally am not impressed by your claims when I see the behavior that accompanies them.
Anyway, that’s my take. We will find out together how it all plays out as time passes through the hourglass. I believe that there will come a time when just about everyone will see that investing in stocks when prices are insanely high is the most foolish thing that an investor can do and that recommending Buy-and-Hold is the most irresponsible and heartless thing that an investment advisor can do.
But the proof is going to be in the pudding. My words do not have the ability to convince enough people for me to get your Goons removed from our conversations and most normal people are not willing to participate so long as your nastiness is part of the equation. If the next price crash generates enough concern for the millions of people who love this country to take effective action, we will all be off to the races. We will have to see how things play out.
Rob
Anonymous says
Uh oh, Rob. Shiller has officially become a goon. He is saying you should not get out of stocks as a long term investor. He is also saying to not use CAPE as a marketing timing tool. His latest comments seem to be targeting you.
http://finance.yahoo.com/news/robert-shiller-interprets-what-the-cape-ratio-says-about-the-market-today-102737135.html
Rob says
Wow. Thanks, man. I don’t consider that even a tiny bit of an “uh-oh.” That article is awesome. I am certainly going to be writing a column about this one, probably more than one. I have bookmarked all of the articles linked in that article and will be reading them all carefully (especially the one in the New York Times). This is exactly what we need — we need to see people talking about this stuff, coming at it from all sorts of angles, generating controversy and debate. This is what I am been waiting for for a long time.
I don’t agree with every word that Shiller says in that article. But what else is new, you know? I would be surprised if it turned out that I did. In instances where I disagree with him, I will spell out why. In instances where I agree, I will spell out why I agree. That’s how the wonderful game works. That’s why this is such a great country. When lots of people come at an issue from lots of different angles, we all enjoy a huge learning experience. This is the future. This is exciting.
My favorite line is where the article states: “He has always gone out of his way to clarify that CAPE is only decent at predicting long-term returns, not short-term swings.” That’s the key. It is of course true that he has said that all along. But people don’t always emphasize that and people often avoid even saying it. You Goons in particular like to give the impression that Shiller does even believe in long-term timing. But that is sure not the sense that I get from reading that article. There are things in the article that could indeed cut that way, that much is so. But there are also things in the article that cut the other way. The job is everyone in this field is to explore these issues in great depth and POST THEIR HONEST VIEWS as to what they come up with so that we can all learn from their takes. Wow!
I doubt that he is targeting me in particular with these comments. But it is certainly fair to say that these comments come closer to dealing with the really important stuff than most earlier comments that we have seen. So this article and the ones cited in it certainly are relevant to The Great Debate.
I am truly grateful to you for letting me know about this, Anonymous. You have added a nice bit of good cheer to my Monday morning, my old friend.
Courage! Onward!
Rob
Anonymous says
It lo Is to be a very embarrassing article for you and now it wipes out any chance of you getting that $500 million windfall.
Rob says
Um — good point, Anonymous.
Truly outstanding!!!
Whatever will I do?
Please take good care, my old friend.
Rob
Laugh says
At what duration will your timing scheme work?
Rob says
It will work when it works, Laugh.
Valuation-Informed Indexing is not a “scheme.” It is the exercise of price discipline. For 145 years, it has always worked. Common sense tells us that it will always work. So whether it will work or not is not an issue. It will OBVIOUSLY work. It always has and our rational human minds tell us it always will.
We cannot say precisely WHEN it will work. Why? Because overvaluation is not a rational phenomenon. The rational mind cannot make effective predictions re irrational phenomena. Irrational phenomena don’t follow logical rules. So how could you go about making predictions about them?
If a rational baseball batter comes to the plate, you can make effective predictions about what he will do in various circumstances. You can say “if the ball is far off the plate, he will not swing because his odds of getting a hit are so small and he gets rewarded by the calling of a ‘ball’ if he holds back from swinging.” But, if an irrational batter comes to the plate (say that there is a batter who has been told that he is going to be sent down to the minors tomorrow and he is thus desperate to hit a home run to ‘show them’), he might swing wildly even at pitches that he has no chance of hitting well. Irrationality makes one unpredictable because it takes one outside of the reach of logic.
The millions of investors whose irrationality has caused today’s P/E10 level may start the move in the direction of rationality tomorrow or they may become even more irrational tomorrow. I don’t know and you don’t know. Shiller did not investigate this point in his work but it is supported by the peer-reviewed research as much as his finding that long-term timing always works. Fama investigated short-term timing and found that it never works. Shiller’s work was built on the base constructed by Fama. Shiller ACCEPTED the critically important findings of Fama and then ADVANCED our understanding by showing that long-term timing always works and is always 100 percent required for investors seeking to keep their risk profiles constant.
Fama’s mistake was not in his findings. It was in his INTERPRETATION of those findings. He found that short-term timing doesn’t wok. One possible explanation of that finding is that the market is efficient (that is, investors are collectively rational). That is indeed one possible explanation of why short-term timing doesn’t work. But it is not the only one.
The other possibility is that the market is NOT efficient, that investors are highly emotional and thus irrational. If that were the case, we should expect to see short-term timing not working (because there is no way to predict irrational behavior) but long-term timing always working (because the very purpose of a market is to set prices properly and so the market must eventually force prices back to fair-value levels through a crash in the event that emotional investors are not open to doing it through a more deliberate process).
The way to test the question is to see whether long-term timing always works or not. If long-term timing always works, that shows that investors are emotional. This is the test that Shiller performed in 1981, finding that long-term timing always works. Every test done since has confirmed Shiller’s “revolutionary” (his word) finding.
If Valuation-Informed Indexing is a legitimate model, it should not be possible to predict short-term price changes. And indeed that is what ALL of the peer-reviewed research shows (both the post-1981 research and the pre-1981 research). So I like to think that that one is settled. People can take guesses as to when the crash comes if they find some amusement in doing so. But the peer-reviewed research does not offer support for their project.
But long-term timing ALWAYS works and is always 100 percent required for investors who seek to keep their risk profiles roughly constant. It is not possible for the rational human mind to imagine how there could be an exception to this rule. Given this reality, we know that the thing that you call a “timing scheme” always will work. That’s what matters. For long-term investors (all middle-class people investing to provide for their retirements are long-term investors), it is the long-term and not the short-term that matters.
Since it is the long term that matters, we all should be seeking to achieve success in the long term. There is now 36 years of peer-reviewed research showing that Valuation-Informed Indexing has been delivering outstanding results for 145 years and that Buy-and-Hold has been delivering poor results for 145 years. I am a Valuation-Informed Indexer.
Your strong preference for a strategy that can only work in the short term is EMOTIONAL in nature, Laugh. There is no rational case that can be made for Buy-and-Hold. That’s why we see death threats and demands for unjustified board bannings and tens of thousands of acts of defamation and threats to get academic researchers fired from their jobs from your side and citations to the peer-reviewed research from the Valuation-Informed Indexing side. You ask over and over and over and over “When is the crash coming?” even though it is a question that doesn’t matter. What you should be asking is “What should I be doing to prepare myself for the crash that I know from reading the peer-reviewed research IS coming.”
The time to adjust your asset allocation to reflect current realities is now, not after the crash. You don’t need to know when the crash is coming to know what to do. The P/E10 value tells you what to do. You are asking the wrong question. And you ask it over and over and over and over, as if it mattered somehow.
It is your Get Rich Quick urge that implores you to focus on the distraction. Your common sense asks your brain “Shouldn’t I be following the peer-reviewed research, shouldn’t I be making an effort to be rational with my retirement money?” And your Get Rich Quick urge answers back “Hasn’t following the pure Get Rich Quick urge worked so far, how are those rational investors following strategies backed by the peer-reviewed research doing today?” And of course he fails to make an adjustment for the valuation level that applies when he reports your portfolio value to you as if it were real without the adjustment. And that your Get Rich Quick urge has to convince you is emotional and he pours it on thick. And so far you have fallen for it.
I don’t know when the crash is coming. I don’t pretend to know. I know that it IS coming. And I know that it will wipe out decades of investing gains if I do not prepare for it. So I have prepared. And we will see how it goes. We will compare notes after the crash that we both know (on at least one level of consciousness) is coming.
You are asking the wrong question, Laugh. That’s why you go around and around in circles. That is why you are in such pain. That is why your brain, which functions properly when facing other sorts of questions, cannot help you in the investing realm. Since the first market opened for business, it has always been emotion that ruined stock investors. The Wall Street Con Men have always pushed highly emotional strategies because that’s where the money is; the secret to getting customers to buy from you is exploiting their emotions.
Buy-and-Hold is just the ultimate expression of the Get Rich Quick approach — it takes the concept to places it had never been taken to before. Imagine a world where there might be research supporting a pure Get Rich Quick investing scheme. That would really be something, wouldn’t it? That’s the tall tale told to us by our Wall Street Con Men friends.
When someone tells you something that your rational brain informs you cannot possibly be so, it’s best to grab tightly to your wallet and get out of the room fast. That’s my sincere take. Not only is going pure Get Rich Quick not the answer in retirement planning, going pure Get Rich Quick is actually the freakin’ problem in retirement planning. Not this boy, you know?
I wish you all good things. That’s WHY I warn you of the dangers of the hopeless Get Rich Quick/Buy-and-Hold garbage pushed so relentlessly by our Wall Street Con Men friends. It makes them rich. It makes us poor. Not my particular cup of tea.
Hang in there, good friend. It gets better. A lot better.
Rob
Anonymous says
With buy, hold and rebalance, we don’t have to wonder if and when it will work. It will always lead to a successful retirement.
Rob says
That’s wrong, Anonymous.
I believe that you believe it. So I certainly don’t have any problem with you saying it. I believe strongly that you should say what you believe and insist on your right to do so in the event that anyone tries to intimidate you into saying something different.
But i sure don’t believe it. So I feel a need to insist on my right to say what I believe. That’s what I have been doing for 15 years now.
You are not going to cover my losses if I follow a strategy that you find appealing but that I find horrifying. So I think that I had better just follow the strategy that I believe in regardless of what you think about it. And of course I should tell my friends both on the internet and off that that’s what I do and I should do my best to respond effectively to any questions that they happen to direct to me as a result.
I wish you all good things. But I would be grateful if you would stop trying to bully me into saying things that I do not believe. I believe that Buy-and-Hold is the purest and most dangerous Get Rich Quick scheme ever concocted by the human mind. I want nothing to do with it. I think of you as a friend even though you have a very different viewpoint re these matters. But I cannot permit even my friends to pressure me into unethical behavior. And it would be highly unethical for me to say that I believe that there is some mystical, magical world somewhere where a Buy-and-Hold “strategy” might work for one or two long-term investors. It has never happened yet in the history of the U.S. market and it is more than a little bit difficult for me to imagine circumstances in which it might happen for the first time.
I naturally wish you the best of luck in all your future life endeavors.
Rob
laugh says
It is looking very likely to me that after 21 years that it will never catch up.
Rob says
You haven’t run the numbers, Laugh. It wouldn’t take much of a price drop for Valuation-Informed Indexing to catch up to Buy-and-Hold for purchases made in 1996 and the valuations that apply today signal a very big price drop. Then the Valuation-Informed Indexer gets decades of compounded returns on the differential.
It is POSSIBLE that the Buy-and-Holders could come out ahead. In my runs of the Scenario Surfer, Buy-and-Hold ends up ahead at the end of 30 years in about 10 percent of the cases. So I don’t want to say that it can never happen. It is just an uncommon event. And, while Valuation-Informed Indexing often wins by very large amounts, Buy-and-Hold’s wins are usually by small amounts.
This is an area where I expect that we will see much more research following the next price crash. It is obviously an important question. We would have hundreds of people researching it today and we would all be much more knowledgeable if it were not for you Goons. But I believe that that problem will go away following the next crash and we will be seeing 36 years of advances in about one or two years of time. We’ll see.
Hang in there, old friend.
Rob