I received an e-mail from academic researcher Wade Pfau with the title “Valuation-Informed Indexing” on January 16 2011. Wade told me that he had listened two times to the RobCast in which I outline nine possible Valuation-Informed-Indexing portfolio allocation strategies and characterized it as “excellent.” He said: “I wrote up the programs to test your VII strategies against buy-and-hold, and I must say that the results look very promising…. I am quite excited about the findings so far. As you say in the podcast, VII should beat buy and hold about 90 percent of the time, and I am getting results that support this for various strategies.”
Wade wrote that he had only been able to find one paper in the literature “which tests something even remotely close to Valuation-Informed Indexing.” This was a paper by Kenneth L. Fisher and Meir Statman titled “Market Timing in Regressions and Reality.” Here is a link:
http://ww.scu.edu/business/finance/research/upload/mkt-timing-in-regression-and-reality-2.pdf
Wade said that he would be criticizing the paper in one of his own forthcoming research papers.
He concluded by saying: ” I hope to have a finished paper in a month or so. I think I may need to ask you a few questions before finishing, but I still have to work my way through all the materials you already sent me.”
I see that you’re not really posting anything at your blog these days, just snips of old e-mails. Boring.
Nice to see Rob Bennett is finally dwindling down to nothing, circling the drain, etc.
Or has he finally gotten his medications balanced?
Nice to see Rob Bennett is finally dwindling down to nothing, circling the drain, etc.
I like the “etc.,” Question Mark. That covers all possibilities.
Please take good care.
Rob
It is hysterical how frequently these guys visit to tell Rob how ineffectual he is. Every few months, when I say “hi”, they keep at it. It is astonishing the control they permit Rob to have over them.
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Rob, I know you are, or were, all in TIPS, locked-in at an all-time high yield. Have you considered how low PE 10 would have to sink to entice you back in the S&P? Or do equities just not fit into your plan altogether?
Here’s some fodder from Hussman, who sees today as being among the 1% worst times to invest in history. The title is wonderfully appropriate for da’ classics majors among us.
Release The Kraken
http://seekingalpha.com/article/543631-john-hussman-release-the-kraken
I like the SA site because one can see responses to Hussman’s weekly commentaries, not seen on his own site where he posts.
Peace
Have you considered how low PE 10 would have to sink to entice you back in the S&P?
My intent is to start buying once we drop below fair value (a P/E10 of 15), Arty. I might start with a 20 percent stock allocation. Then I would gradually increase the stock allocation as the P/E10 value dropped. I would like to be at something over 50 percent when we go to a P/E10 value below 10. I would like to be at 80 percent when we go to a P/E10 value of 7 or 8.
Rob
If Rob is being honest about 20% stocks at P/E10 15 and 50% at P/E10 10 then he should have been about 40% stocks on March 6 2009 because P/E10 was 11.7. The archives however show that on that day neither Rob nor arty were at all interested in allocations to stocks.
http://arichlife.passionsaving.com/2009/03/04/podcast-72-when-stock-losses-are-true-losses-and-when-they-are-not/#comments
Rob: Wow. A tight window where a lot of allocation action occurs. Waiting til fair value and then only doing 20% but then accelerating fast. May have to wait a long time to get to 15. Still, this (and other discussions) just shows the range of personal implementation strategies based on the metric.
A tight window where a lot of allocation action occurs.
You’re going to force me to give the long answer, aren’t you?
My impression from review of the historical data is that that “tight window” may remain in place as long as ten years. People don’t all wake up one morning and decide to be rational.
My true focus is not the P/E10 number. It is the level of rationality in the market. The P/E10 metric is just a signifier for that.
Forget P/E10. We can come at it from another direction. Say that every board and blog on the internet opened itself to honest posting on SWRs and lots of other critically important questions. That would be a very good sign. That’s what we’re really looking for. Today’s high P/E10 is really just an indicator of how much emotional pain Buy-and-Holders are in today.
The significance of the “15” is that we have to go to fair value for the market to be able to continue to function. So I think of that one as a lock. The “7” is NOT a lock. The “7” is 100 percent irrational. It would be INSANE for us to price stocks at one-half fair value. If we do that, we are going to bring on the Second Great Depression.
So if I see signs that we are going to open the internet to honest posting on stock investing topics, that tells me that we will probably never go to “7,” that it is safe to increase my stock allocation without seeing that. But if the ban remains in place, that tells me that we are going to continue destroying ourselves for a while longer. There’s no benefit to being heavily in stocks when we enter the Second Great Depression.
I want to invest my money in an asset that will grow. Our economy is trying to grow like gangbusters. So investing in the U.S. economy through stocks makes all the sense in the world today. The problem is this darn ban on honest posting. We cannot SEE that growth in the real world without first educating all the people who invest in stocks about how stock investing works (as revealed by the last 30 years of academic research). Once we do that, it’s downhill sledding all the way home.
So what I am really waiting for is an emotional change, not a P/E10 change. When I give the “7” number for when I would go with 80 percent stocks, I am using a presumption that things will turn very slowly, as they did with the economic crises caused by the three earlier out-of-control bulls. I don’t really expect to see that.
I don’t think we can survive a slow change. Nor do I think we are doomed to what a slow change would mean for us. We now have the internet available to educate people about the realities. If we make use of the technology available to us, we can bring the economic crisis to an end in six months (once people see that they can retire many years sooner than was ever before possible, they will feel free to start spending again and the economy will take off).
Once the Buy-and-Hold Crisis has been brought to an end, the stock market should be in good shape for hundreds of years. Bull markets will no longer be possible once we permit honest posting. Neither will bear markets. And there is no reason to think we will be seeing major economic crises since all four that we have seen since 1870 were caused by the promotion of Buy-and-Hold strategies.
The “tight window” we are dealing with here is the light switch that flips when we permit honest posting on the internet. If we do that, there will be no stopping us for many years to come. The investing insights we have developed over the past 30 years are of more power than all the investing insights developed in all the time that preceded this era combined. If we don’t flip the switch, we all go down together. There is today too much money invested in the stock market for us to survive following Buy-and-Hold strategies.
We either move on to the Garden of Eden or we die of thirst here in the desert of willful ignorance. We can see the Garden from here. It is a mile walk. But some are frightened by the idea of having so much clear and clean and pure water available to them after years of suffering a hateful thirst. We have become so accustomed to our chains that the thought of being free shocks and repels us.
Whachagondo?
Rob
I hear you, Rob.
In one sense, I also see the PE 10 number as an indication of rationality as often the two can be correlated—depending on how we got to a given level. Now, I do know we have discussed that there can be two different “15”s and how one *arrived* there can matter.
Still, I prefer the mechanical guidance supplied by the number than my trying to asses rationality, since I don’t want my *own* emotions to influence things. Having a mechanical shift to an allocation—already already in place—helps with that. Fair value is fair value and I don’t think I can make a huge mistake on that even as the market can remain irrational for some time (see 1996 for one extreme upward and the 70s for another, downward).
Contrariwise, I have many money managers as clients, and one of them read about PE 10 and Hussman and we are having good talks on the topic. (I do mention your work.) He is more of an “intuition” guy and puts faith in that. I won’t do that in investing, though I always do in other life issues. We continue to have productive discussions.
The archives however show that on that day neither Rob nor arty were at all interested in allocations to stocks.
That’s not so, Pantograph.
I was recording RobCasts on a daily basis in those days. Go listen to one. At the start of every RobCast recorded in those days I said that “the long-term value proposition for stocks purchased at today’s prices is strong.”
I did not personally make a buy, however. I gave serious thought to it. I don’t make buys in a day. I go through a slow, deliberate process. I brought the subject up with my wife. We agreed to talk it over some more in a week or so. When the week was up, prices had shot up. So the value proposition was no longer there.
Did I miss out?
I did not. If stocks were never going to be available at good prices again, I would have missed out. But that’s not how it works. There has never in history been one time when stocks were selling at poor prices for a time and they did not eventually sell again at good prices. So no worries.
Now —
Would I have done well in 10 years if I had bought stocks at those prices? Better than I will do with the IBonds paying 3.5 percent real? I am confident that I would have done better in stocks.
But at what emotional price?
The numbers say that we are headed into the Second Great Depression. We will have good prices at the end of 10 years. But those who bought stocks in those days may have to live through eight years of hell to get to the promised land. Is it worth it?
It’s worth it for some. It’s not worth it for others. For me, it was a close call. I was okay with a small allocation at a certain price. But only if I had time to think it over and proceed methodically. It wasn’t possible to do that. So I spared myself the eight years of emotional hell (and the better long-term returns that would have gone with it if I really did stick with my plan through the eight years of emotional hell.)
People have a hard time keeping in mind the difference between short-term timing and long-term timing. With short-term timing, you have to make sudden moves. That’s a big reason why it never works. With long-term timing, you always have lots of time to think things over. Stocks were at good prices from 1975 to 1995. That’s 20 years. Stocks have been at poor prices from 1996 through today. That’s 16 years.
There’s no picking tops and bottoms with Valuation-Informed Indexing. That’s why it works.
Rob
I have not been out of stocks in the last 10 years. I have recognized the sometimes pain of that choice, but I was invested throughout the crisis. I tend to be a conservative investor so did not take huge losses, but I’m considering a more aggressive position when valuations favor.
So, I still believe “fear is useful” when it comes to learning about investing. One can’t game-theory investing; it is essential to actually have “skin in the game” to learn how emotions play.
Still, I prefer the mechanical guidance supplied by the number than my trying to asses rationality, since I don’t want my *own* emotions to influence things. Having a mechanical shift to an allocation—already already in place—helps with that.
I hear you loud and clear, Arty. This is an extremely important point.
People tend to fall in one category or the other. Some want a mechanical approach (because they don’t trust their emotions). Some want to go with their intuition (because they don’t trust the people reporting the numbers not to twist them).
I take a middle-ground position.
I love mechanical approaches. That’s why I was so drawn to Buy-and-Hold. I cannot stand it when two “experts” offer entirely different takes. If they are saying opposite things, they cannot both be “experts” in the subject matter. To develop expertise is to master a subject. If one has mastered a subject, one should know something about it. If one knows something about a subject, one should not be dramatically at odds with other experts in the field.
I also see the need for some reliance on intuition. Investing is a HIGHLY emotional endeavor. Emotions can never be translated into numbers with 100 percent success. P/E10 is the tool that comes closest to performing a good translation. But I do not view P/E10 as a perfect tool. So I am not willing to go with or to recommend a purely mechanical approach.
The full reality (for me!) is that investing involves both the hard, rational stuff (the economic realities) AND the soft, emotional stuff (mispricing). We have to connect the two sides of our brains to do well at this game. We need to hear from experts with a variety of personality types to obtain good advice.
Buy-and-Hold was a huge advance. But it turned into a disaster because the personality type responsible for this advance (INTJs) is a personality type that has a very hard time listening to other points of view or acknowledging mistakes. When we supplement the insights of the Buy-and-Holders with the insights of the Valuation-Informed Indexers, we will make the insights of the Buy-and-Holders 20 times more powerful. Because, when the insights developed by those who focus on the numbers are reined in by the insights developed by those who focus on the emotions, the numbers will be ACCURATE and REAL and INFORMED.
The challenge of stock investing is combining these two seemingly uncombinable forces. It’s not all about intelligence. And its not all about emotion. It’s about how those two forces work together over the course of time to produce highly predictable results that most of us cannot see because we have elected to blind ourselves to the realities.
Rob
Rob wrote: “I also see the need for some reliance on intuition. Investing is a HIGHLY emotional endeavor. Emotions can never be translated into numbers with 100 percent success. P/E10 is the tool that comes closest to performing a good translation. But I do not view P/E10 as a perfect tool. So I am not willing to go with or to recommend a purely mechanical approach.”
Good conversation, that, as you point out, also embraces the buy-and-hold philosophy.
We all get tested only in the moment, in the cauldron. It is precisely because of emotions that I am willing to accept a mechanical implementation—even an imperfect one as ALL approaches must be.
I recall thinking in the downturn, as I added to position on the way down, that I was just throwing good money after bad. That was the *feeling*. I had acted on the feeling, I would not have enjoyed the rebound.
Still, this is not a perfect science, and to that I agree.
It is precisely because of emotions that I am willing to accept a mechanical implementation—even an imperfect one as ALL approaches must be.
I understand, Arty. What you are saying makes perfect sense.
I think that it is a feeling very much along the lines of what you are describing here that causes some Buy-and-Holders to react so violently to the Valuation-Informed Indexing concept.
Buy-and-Hold represents logic and data and research in a field that has long been dominated by mumbo jumbo. Buy-and-Holders are relieved that we have finally figured this stuff out, that we finally have something objective to go with. And then this guy comes along and says “you got all the numbers wildly wrong.”
The Buy-and-Holders are very much on the right track, in my assessment. I admire their work and I understand where they are coming from. I see it as an historical quirk that we just didn’t happen to have Shiller’s research available to us in the early 1970s, when Buy-and-Hold was being developed.
It’s a tragic coming-of-age story that we are living through today. We almost got it right in the 1970s when we made the shift from childish investing strategies to adolescent ones. But almost isn’t quite good enough for grown-ups. We’ve got another step to complete.
Rob
Buy and holders are right too.
Each side in this holds some portion of “the truth”.
After all, valuation informed guys will usually be HOLDING for the most part, and making only occasional shifts. Though the shifts can make a big difference.
Buy and holders are right too.
They are right about many things, Arty.
They are not right about one thing. They got that one thing wrong because the research needed to understand that one thing was not available to them at the time they developed their model. Still, they are wrong about that one thing. And it’s an important part of the story.
Each side in this holds some portion of “the truth”.
I wouldn’t say it that way because saying it that way suggests that there is some middle ground between Buy-and-Hold and Valuation-Informed Indexing that is an acceptable compromise. The question of whether the market is automatically efficient is a “yes” or “no.” There’s no middle ground on that. If valuations affect long-term returns, the market is not efficient. If the market is not efficient, it’s not possible to Stay the Course unless you are willing to change your stock allocation from time to time.
After all, valuation informed guys will usually be HOLDING for the most part, and making only occasional shifts.
Yes, we have that in common. And that’s due to the huge contribution made by the Buy-and-Holders. It was the Buy-and-Holders who showed that short-term timing never works.
Rob
Here we agree and disagree (strongly), as before.
I believe the market is mostly efficient (yes) in that it is difficult to exploit the inefficiencies for abnormal profit—especially with any consistency. That’s the key. There is no solid evidence that such is being done and even the best of those guys can’t keep doing it.
Markets can stay irrational a long time and still be consistent with EMH. This is one thing the critics of EMH don’t understand.
Bubbles and panics do not make the market inefficient; that is a myth based on misunderstanding of EMH.
The largest piece of common ground between B&H and sensible Valuations guys is that HOLDING—for the most part— is the thing most done by both, even if the valuations guys respect long-term valuations with sometimes massive shifts in their equities in response. But these shifts should be rare.
However, in my opinion, there are many “closet” valuations guys among the DIY B&H crowd who also take heed of valuations (at least at extremes). Some of the guys include famous B&H authors who have let those beliefs be known in various ways.
Bubbles and panics do not make the market inefficient; that is a myth based on misunderstanding of EMH.
I’m grateful to you for sharing your thoughts, Arty.
If you prefer just to acknowledge that we disagree on some points and let it go, I am 100 percent fine with that.
If you want to explore the disagreement, I think it would be fair to say that it is highlighted by the words quoted above.
Rob
Rob,
Always good to talk shop with you. Yes, the highlighted commentary above is the place where the fun starts!
We can come back to EMH another time, in a dedicated way, though I think we have discussed this one before. I’m off for a trip tomorrow, which will be a bit rough (which was why I was off prior to it!). And the topic is one that deserves some length, though many far smarter than I have had at this one before (Fama, Shiller, et al).
Damned glad I came here (well, your original site) years ago. Doing so impelled many good explorations and readings for me (many authors, peer-reviewed papers, etc.), and I found the Shiller work via you; that alone was very cost-efficient! Keep fighting the good one and don’t let the nitwittery distract you. More good people pay attention than you may suspect.
I’ll say “Hi” when the dust clears.
Peace.
Arty
P.S. Keep checking-in with the Hussman weekly via the Seeking Alpha site. The resulting commentary there may spur some fresh material for discussion here.
We can come back to EMH another time
That sounds fine, Arty.
Damned glad I came here (well, your original site) years ago.
That’s kind of you to say.
don’t let the nitwittery distract you.
Please understand that I don’t let the nitwittery itself concern me even a tiny bit. What concerns me greatly is that others empower the nitwittery by letting those who put it forward exercise a veto power over what can be said at our boards and blogs. That renders our boards and blogs corrupt enterprises. It is my aim to bring that sort of thing to a total and complete stop by the close of business today.
More good people pay attention than you may suspect.
Those are certainly encouraging words. Thanks for bringing a measure of cheer to my Friday morning.
Peace.
Backatcha!
Rob