I’ve posted Entry #332 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Never Before in U.S. History Have We Seen Today’s Level of Overvaluation Continue for So Long.
Juicy Excerpt: An exceedingly helpful paper on the topic of this column (the merit of valuations-based market timing) was recently published by Valentin Dimitrov of Rutgers Business School and Prem C. Jain of the McDonough School of Business at Georgetown University. It is titled: Shiller’s CAPE: Market Timing and Risk.
The paper states that: “We find that even when CAPE is in its ninth decile, future 10-year stock returns, on average, are higher than future returns on 10-year Treasurys. Thus, the results are largely consistent with market efficiency. Only when CAPE is very high, say, CAPE is in the upper half of the tenth decile (CAPE higher than 27.6), future 10-year stock returns, on average, are lower than those on 10-year U.S. Treasurys.” So the paper is not generally supportive of the Valuation-Informed Indexing concept. However, it provides a wealth of data and analysis that I believe should be reviewed by all with an interest in coming to a better understanding of many questions raised by Robert Shiller’s “revolutionary” (his word) 1981 research showing that valuations affect long-term stock returns.
I find it amazing that Valuation-Informed Indexers and Buy-and-Holders look at the same historical return data and come to wildly different conclusions re what it signifies. I’ll describe one way in which this is so in the words below.
Rob, what do you think of Shiller’s comment today that the market could go up 50% from here? And how do your intelligence and experience compare to his?
I agree that the market could go up 50 percent from here. There is nothing even a tiny bit controversial to what he is saying. All the research shows this.
I get the sense that Buy-and-Holders take some comfort in this kind of statement. I think that’s a mistake. Prices are already insanely high. A 50 percent jump would make things worse. Why would you take comfort in that? It’s like a manager of a baseball team saying: “We are down by six runs but it’s entirely possible that after a few more innings we will be down by 11 runs. It really could happen!” Um….
My sense is that the Buy-and-Holders think that they will someday be able to spend that money. That’s not how it works. All overvaluations disappears into the mist in time. So the 50 percent gains are going to disappear, just as will all the phony gains that they were counting on before the 50 percent gains came into play. They are going to lose it all. So why be happy about being able to fool themselves for a few months?
The only stock gains that matter are real gains, gains produced by the economic realities, not by overvaluation. I agree with what Shiller is saying but I don’t see how this is a positive thing for stock investors. It’s an unfortunate thing. We should all want stocks to be priced properly at all times. The market offers its greatest possible value proposition when the P/E10 is at fair-value levels (a P/E10 of 15).
Rob
10 years from now, stocks are likely to be higher than they are now. I don’t know of anyone that can predict the rise or fall along the way. As such, it makes sense to just buy, hold and rebalance.
What you say about stock prices likely being higher in 10 years was NOT true in January 2000. In January 2000, prices were so high, that the likely real 10-year return was a negative number. People investing at that time needed to know that. Most didn’t know it because of the relentless promotion of the smelly Buy-and-Hold garbage. Lots of people are facing failed retirements or delayed retirements because of the many ways in which they have been misled by the Buy-and-Holders over the years.
You are correct that at today’s valuation levels stocks are likely to be higher in 10 years than they are today. We agree on that much. And we certainly agree that no one can predict the precise times when prices will rise or fall. But you couldn’t be more wrong in your conclusion that it thus “makes sense to just buy, hold and rebalance.”
There are other asset classes that will be offering positive returns over 10 years. And some are far less risky than stocks. If stocks are priced so that they offer small positive long-term returns while another asset class offers somewhat higher long-term returns at greatly reduced risk, it makes all the sense in the world for investors to move a portion of their assets into the better performing asset class. It’s not even possible for the rational human mind to imagine any possible downside.
Anyone who tells you that one particular asset class is always the best choice regardless of price is trying to sell you something, Anonymous. If a car dealer told you that the particular brand of car that he made a profit from was the only car worth buying no matter what price he charged, you would laugh at him. Yet you lap up the deceptive marketing speak of the Wall Street Con Men. They say there’s no such thing as a free lunch. I think it would be fair to say that a good corollary is that there is no asset class that is worth buying at any possible price.
It defies logic to believe that there is no price at which stocks become a bad choice. There is such a price and every investor needs to know what that price is. I think it would be fair to conclude at this point in the proceedings that the Wall Street Con Men very, very, very much do not want to see us talking amongst ourselves about this sort of thing. Gee, I wonder why. Do you think it might be a tiny bit possible that the hundreds of millions that they have managed to stuff into their pockets through the promotion of the Buy-and-Hold “strategy” might have something to do with it?
Yeah, I was thinking that that might be one factor at play in all this too.
Saint Jack!
Rob
“And some are far less risky than stocks. If stocks are priced so that they offer small positive long-term returns while another asset class offers somewhat higher long-term returns at greatly reduced risk, it makes all the sense in the world for investors to move a portion of their assets into the better performing asset class”
Which assets are you referring to? Tell us what you recommend.
I recommend that you buy stocks in the same way that you buy everything else — compare the pros and cons of stocks at a particular time with the pros and cons of the other asset classes available to you at that time.
In other words, don’t fall for the smelly Buy-and-Hold garbage pushed so relentlessly by our Wall Street Con Men friends!
Oops! Did I say something “controversial” again?
Rob
“I recommend that you buy stocks in the same way that you buy everything else — compare the pros and cons of stocks at a particular time with the pros and cons of the other asset classes available to you at that time.”
In other words, you can’t or won’t say.
You should always buy as much stocks as possible, Anonymous.
Regardless of price.
It will make our Wall Street Con Men friends very, very, very happy.
Rob
Most people just go to the grocery and buy whatever is there. So it sounds like you fully support buy and hold.
When the price of milk increases, people complain.
When the price of stocks increase, people cheer.
That’s the problem, Laugh. It’s an emotional thing.
People can be educated to complain about increases in stock prices just as they complain about increase in milk prices. But those of us who want to help out are prohibited from doing so because it makes the Buy-and-Holders feel bad for people to learn the realities.
That has to change. If our economic system is going to survive, we need to find a way to provide access to honest and accurate posting about scores of critically important investment-related topics. We are on our way. We are as a society working our way through a process that gets us there and that liberates us all from the Get Rich Quick thinking that is at the core of the Buy-and-Hold project.
I am doing my part. I love my country. So I am doing my part.
You Goons desperately want to stop me. So you are doing all you can to hold me back.
The people of the United States will decide the matter. As one of you Goons put it not too long ago, the community will have its say. But you Goons make it sound as if the community decisions that resulted in bans on honest posting are final decisions. They are not. Communities are permitted to rethink matters after the members of the community lose most of their retirement savings. That’s certainly what happened with the community that celebrated the owner of the Madoff Fund as “Saint Bernie.” You don’t hear anyone referring to him as “Saint Bernie” today while he watches television in his prison cell.
The community of people who comprise the United States of America is working its way toward achieving the biggest advance in its understanding of how stock investing works ever experienced in history. We are in the process of coming to see that buying stocks is just like buying milk, there are some prices at which the value proposition is amazing, there are some at which it is good and there are some at which it is poor. Once we all start buying stocks the way we all already buy milk, we will never again see another bull market. Which means we will never again see the bear markets that inevitably follow from bull markets. Which means that we will never again see the economic crisis that inevitably follow from bear markers.
I don’t like economic crises. They hurt millions of good people. So I oppose the Buy-and-Hold “strategies” that create them. I follow and recommend the first true research-based investing strategy, Valuation-Informed Indexing. I am 100 percent confident that everyone in this field will be working with me to help spread the word re Valuation-Informed Indexing once we all see the damage done by the promotion of Buy-and-Hold with the arrival of the next price crash. But we are going to have to wait to see how things play out in the real world to get you Goons on board. I have a funny feeling that you are not going to be willing to come clean just because I put forward some words about things I am 100 percent sure we are going to see happen in coming days.
Can you just calm down a bit until the next crash arrives and and then resume these discussions at that time? I sincerely believe that that’s the best way to proceed given the circumstances that apply today.
I wish you all the best that this life has to offer a person in any event, my long-time Goon friend.
Rob
I’ll make another point that relates to your “buy whatever is there” comment.
People are looking for something when they buy milk. Let’s say that they are looking for something to put on their cereal. When milk prices rise too high, they look for alternatives. Perhaps they buy that powdery stuff that you mix with water to get milk but that is not quite the same thing as milk sold in bottles and which thus might not be affected by the price increase for milk. Or perhaps they give up eating cereal for breakfast and switch to English muffins. Milk sales go down and English muffin sales go up until the price of milk returns to reasonable levels.
That’s how markets work. It is the demand for a good value proposition on the part of people buying a product offered for sale that creates the magic by which the market is able to set the price properly. This is how it works in every market that exists except the stock market. In the stock market, there is no price resistance. The newspapers report that the price of stocks has doubled over the past year and people throw parties to celebrate the good news. A market becomes dysfunctional when the people being hit with increased prices jump for joy about it. When the people buying the product refuse to do their job of looking for alternatives to a product that becomes overpriced, the only way that the market can get prices down is to crash them. And that hurts all of us in very big ways.
People buy milk to have something to put on their cereal. People buy stocks to create an income stream that will support them in their old age, when they can no longer work. When the price of milk rises so high that English muffins offer a better value proposition, people switch from milk and cereal to English muffins. When the price of stocks rises so high that alternative asset classes offer better income streams, people need to switch from stocks to those other asset classes. In January 2000, stocks were offering a likely 10-year real return of a negative 1 percent. IBonds were offering a certain return of 4 percent real. Yet people continued to shove money into stocks and ignored IBonds. What the h?
They did that because of social pressure. Every newspaper they picked up told them how there was some mystical, magical “research” that showed that stocks are worth buying at any price. It was an obvious lie but it was not a lie that many of the people who refer to themselves as “experts” in this field dared to give voice to. The other “experts” (in marketing!) were making millions pushing the smelly Buy-and-Hold garbage. If someone came forward and told the truth about what the peer-reviewed research shows, it would blow their deal. So, to keep our well-paid careers humming, most of us agree either to lie about this stuff or at the least to pull our punches and put forward lots of word-game statements about how “market timing doesn’t work” (without specifying whether we were talking about short-term market timing or long-term market timing).
I don’t play that game, Laugh. I tell it like it us, to the best of my ability. You hate me for it. So be it. I don’t hate you. I love you all the same and I believe that there will come a day when you will love me too. It will happen following the next price crash when you will no longer possess a motive to lie to yourself about the value of your stock portfolio. You won’t need to divide by two to know the accurate numbers in those days; the next price crash will perform that tricky mathematical step for you.
I buy stocks in the same way that I buy everything else I buy. I compare the value proposition being offered with the value proposition being offered by alternative purchases and I go with the best one. That’s what I advise all my friends to do. The Buy-and-Holders say that we should never, never, never do the comparison, that we must always just take it on faith that stocks are best regardless of the price at which they are being sold. This lie has done more harm to human beings than any other lie ever told in the history of personal finance. I want nothing to do with it. I have hopes of going down in history as the one person who did more than any other to EXPOSE this ugly Buy-and-Hold/Get Rich Quick lie.
We all will be free to discuss THOUSANDS of exciting investment-related topics once this Buy-and-Hold Lie has been fully exposed far and wide. I can’t wait, you know? I built the Retire Early board to facilitate discussion of just those sorts of issues and I know from the reaction to my May 13, 2002 post that a good percentage of that board community was as excited about that prospect as I was. It’s not a majority of investors that is interested today, not by a long shot. But it is perhaps 20 percent of the community of investors that has an interest in hearing these issues explored. 20 percent of the community of all investors is millions of people. That’s good enough for me. I am on the side of those millions. I will continue to speak up on behalf of those millions when their right to hear both sides of the story is attacked by the members of Jack Bogle’s various internet Goon squads.
We will see how it all plays out, my good friend.
Rob
Since I own a lot of stocks why wouldn’t I cheer when they go up?
If they are priced above their real value, there is no long-term benefit in a price increase. You are just going to lose the money down the road anyway. So what’s the point?
And if you are still buying stocks, you are paying a big penalty for these price increases. Your investing dollars get you fewer stocks. That hurts you big time over the long run.
The only time when you should be happy with price increases is when your stocks are priced below their fair value. Any move in the direction of fair value is a plus.
Stocks can increase in price by 6.5 percent real per year and not become overpriced if they are priced at fair value at the beginning of the year. Those gains represent economic realities. To pretend that gains of more than that are real is to engage in fantasy thinking. Not good.
Rob
6.5 is just a number you decided on. Looking across global markets in out of sample testing makes this assumption look silly.
In any case 6.5 is irrelevant. The return sequence is lumpy and the percentage of stocks held changes over time for most people.
6.5 percent real is the average long-term return produced by the U.S. market over its entire history, Laugh. It is not a number that I decided on. It was decided on for me by the peer-reviewed research in this field. Valuation-Informed Indexing is a research-based approach. I don’t have to decide on anything because I use the research as my guide to how to invest in stocks. The core idea is that it is likely that stocks will continue to perform in the future at least somewhat as they have always performed in the past. I got this idea from my good friend Jack Bogle. I love the idea because it takes the subjectivity out of stock investing. The historical return data is an OBJECTIVE source of guidance. It is not what I say, it is what the entire history of the market says.
I don’t know what it is that you are trying to communicate when you say that “the return sequence is lumpy and the percentage of stocks changes over time for most people.”
Rob