He said: “If you do have any suggestions about how I explained why long-term market timing works, but not short-term market timing, I would love to hear it.” He added, though, that he did not want me to have to retype points I had already made in materials at my web site. He explained that: “I think this is something you’ve addressed in your various articles, and I will read everything before finalizing my paper.”

Re Larimore’s mischaracterization of Bogle’s position, Wade said: “I was thinking about taking Taylor to task for this, but in the end I’ve decided not to. That guy is over 80 years old and he seems to be a bit of a follower. I don’t really feel a need to argue with him at this point. Especially since other people have already pointed it out to him and he doesn’t seem to care.”

Wade told me that he had “big news.” He had posted preliminary results of his research:

http://www.bogleheads.org/forum/viewtopic.php?t=67093

He noted that “Richard disappeared after I took him to task about being full of it with regards to ‘standard statistics.’ ” He explained that: “I think on those message boards that all those guys repeat that mantra so much that they do not think it is standard statistics, when in fact the issue of rolling periods is a rather advanced topic well beyond the reaches of Statistics 101, and their assumptions are not necessarily right.”

Related posts:

1. “Unless Taylor Larimore [Co-Author of the Book The Bogleheads Guide to Investing) Has Had Some Secret Discussions With Bogle That No One Knows About, He Is Mischaracterizing Bogle’s Position.”
2. “Bill Bengen & Wade Pfau & John Bogle Should Not Be Forgetting About Those People. The Journalists & Economists & Politicians Should Not Be Forgetting About Those People”

Wade:

That’s super. I am grateful for your constructive efforts.

1) CJKing is an awesome poster, probably the best I have ever seen on this topic. If it’s possible to contact him through a private e-mail system there, he can probably be of help. He is extremely knowledgeable re this topic and also has spent
years thinking carefully through all the angles.

2) His recommendation to read Valuing Wall Street was a great one. Smithers uses a different valuation metric. John Russell did some research seeking to determine which metric worked best (P/E10 or Tobin’s Q). He ultimately went with P/E10 but my recollection is that he also had generally good things to say about Tobin’s Q.

3) John Russell wrote an article making the point you were making re the size of the data set. He certainly agreed with your intuitive sense re this. I will try to track down that article.

4) Richard’s point is the most important, in my view. People need to understand WHY long-term timing works but short-term timing does not. I struggled with this for a long time. Once I was clear on the premises of
the new model, I was able to understand all sorts of aspects to the question that I had been blind to before. If you want me to say more on this (now or later), please just let me know and I will expand on the point.

5) Norbert Schlenker’s behavior is inexplicable. He banned me from his board. However, I think his substantive comments on the thread where he supplied the graphic were perfectly fair. He expressed a certain skepticism but it was more a cautious skepticism than a rigid skepticism. And the one big negative he pointed to — the success of Buy-and-Hold in the late 1990s — no longer applies since the crash. It’s of course not his fault that he happened to prepare the graphic prior to the crash.

6) You described Benjamin Graham’s take properly. I will try to track down an article that quotes his words.

7) Bogle has said that Valuation-Informed Indexing can work:

http://arichlife.passionsaving.com/2009/07/28/bogle-says-valuation-informed-indexing-can-work/

Unless Taylor Larimore has had some secret discussions with Bogle that no one knows about, he is mischaracterizing Bogle’s position. In fact, Bogle warns about the effect of overvaluation in nearly every speech he gives. Bogle himself timed the market successfully! He has said in published interviews that he lowered his stock allocation to about 30 percent at the top of the bull partly because of valuation concerns. He obviously is ahead
today because of his decision to do that. Taylor is of course aware of this. These points were made dozens of times to him in threads that reside today in the Post Archives of the Vanguard Diehards board.

That’s a great thread! I am sure that that is going to help some people gain a better sense of the realities.

Rob

Related posts:

1. “I Was Thinking About Taking Taylor [Larimore] to Task for This [Mischaracterizing Bogle's Position]…. Other People Have Already Pointed It Out to Him and He Doesn’t Seem to Care.”
2. Larimore Acknowledges Errors in Bogleheads Guide, Then Retreats into Further Defensiveness

He described a thread that he started at the Bogleheads Forum:

http://www.bogleheads.org/forum/viewtopic.php?t=67093

He said that it was not his intent to start a debate on the merits of Valuation-Informed Indexing since he hadn’t yet finished his research paper. However, he wanted to know if anyone was aware of studies concluding that Valuation-Informed Indexing does not work. He explained that: “Once I finish my study, I would like to refer to the concept as Valuation-Informed Indexing, but I called it long-term market timing in this post since I really was trying to avoid controversy and just uncover more background reading materials.” He reported that: “Two papers by Fisher and Statman are still all I can find that provide evidence against long-term market timing.”

Related posts:

1. New Wade Pfau Study Shatters Market Timing Myths, Shows That Long-Term Timing ALWAYS Provides Higher Returns at Reduced Risk
2. Academic Researcher Wade Pfau: “As You Say in Your Podcast, Valuation-Informed Indexing Should Beat Buy-and-Hold About 90 Percent of the Time, and I Am Getting Results That Support This”

Wade’s e-mail further discussed the Fisher and Statman study. He explained that for purposes of the paper he was writing he thought it would be proper to rebalance the tested portfolios each year. He asked whether I viewed annual rebalancing as a violation of the tenets of Valuation-Informed Indexing. My response is set forth below.

Wade:

I agree that rebalancing is the theoretically proper way to do things. I don’t think it is required as a practical matter. But rebalancing is theoretically better and more appropriate.

I’ll tell you the biggest problem that I aware of in testing this. There are four major cycles in the historical record (one producing a major bear in the early 1900s, one in the 1930s, one in the 1970s and one today). Each of the P/E10 levels should be (and my sense is that the data generally shows this to be so) producing worse results during the years following a bull market top than it does in the years leading up to a bull market top. For example, we are now in the low 20s. It was not a bad time to be in the low 20s when we hit the low 20s in the early 1990s. Investing heavily in stocks at the low 20s today is probably going to turn out much worse because we are probably on the way to 7 or 8 in the not too distant future.

The downside of reporting different results for the different ends of a major cycle is that you cut an already too small data set in half. So I don’t say that this should be done. But it does affect the result and not considering which end of the cycle the P/E10 level appears on causes confusion for newcomers who feel that each P/E10 level should dictate a single stock allocation.

John and I (really John — he did all the statistical work, I just asked questions and made suggestions as we went along) did not consider the effect of what stage of the cycle the P/E10 level appeared in when we developed The Stock-Return Predictor (which gives the likely return for each P/E10 level). We developed The Investor’s Scenario Surfer (which lets the investor go through a realistic, random 30-year returns sequence and see whether his choices of valuation-informed allocation levels beats a Buy-and-Hold allocation strategy) later and we did include an adjustment for the stage of the cycle in which the P/E10 level appears in that one. I don’t know how John did it but it might be possible to figure this out by looking at old articles and discussions and e-mails (he stored all his work materials on a Yahoo Finance site that was shut down, causing the materials to be lost!). The calculator forces the user to choose not only a starting-point P/E10 level but whether the P/E10 level is occurring in a “Normal” market or a “Bear” market. John applied some sort of filter so that the return sequences that pop up in the early years of the bear market scenarios are a bit more likely to be bad ones (as is true in the record, of course).

The reason why this happens is not important in terms of the statistical analysis but is highly important in terms of the big picture questions. Bull markets cause massive misallocation of resources (because all investors make bad spending choices, thinking they possess more lasting wealth than they do in fact possess). What’s really going on is that bull markets are causing economic crises (the Buy-and-Hold theory is that it is economic developments that are causing stock price changes, but it appears to be the other way around — stock price changes are causing economic developments). I think that part of the reason why the general phenomenon is not widely appreciated today is that it requires a reversal of thinking on so many different fundamental points.

I am not trying to cause confusion here. I’m just saying this as a follow-up to your point about the late 1990s being the best time for Buy-and-Hold. The core principle here is that all overvaluation is the product of investor self-deception (in a world of rational investors, prices would always be set properly). So the biggest bull markets are going to be at one and the same time the most dangerous time to invest in stocks and the time when theories that downplay valuations are going to become most popular. We couldn’t have had the huge 1990s bull without Buy-and-Hold having first become the dominant theory. This is one of those cases where the observer is causing the results of his experiment by watching things. Buy-and-Holders saw only half of the story and their inability to see the other half caused millions of others not to believe that the other half matters, which caused data to be generated that for a time seemed to vindicate the findings of the Buy-and-Holders.

To become totally objective about this, someone would have to stand outside of bull and bear markets and do the tests. But we are of course always in one or the other or on our way to one or the other. We are on our way to a time when only
studies taking extreme bear positions will be considered in line with the data (because the data of that moment will make stocks look the worst they have ever looked in history).

Anyway, I think it would be a theoretical plus to have an adjustment for whether the P/E10 level occurred in the bull phase of a secular bull/bear cycle or in the bear phase of it. But I have doubts as to whether such an adjustment can be included as a practical matter (because of the limited data set).

Another statistical problem that John encountered is that the data seemed to behave differently pre-1920 and post-1920. The effect of valuations has generally been stronger in the post-1920 years (John has an article where he discusses
reasons what might be the reasons for this). John’s practice was to use data from 1921 forward when possible and to incorporate the earlier data only when it was needed to generate statistically meaningful results (for example, he needed a larger data set when we made 60-year predictions in The Stock-Return Predictor).

Rob

Related posts:

1. Two-Level Switching In a P/E10 Level = 14 Market
2. How to Change Your Stock Allocation in Response to Valuation Shifts

Wade:

Your last sentence is the amazing thing. I cannot get over this. Shiller’s book was very well received and it has been out for over 10 years. But I have not been able to find anyone who has made a serious effort to explore the practical strategic  implications of Shiller’s work. It’s just been sitting there waiting for someone to jump on it.

The subtitle of the paperback version of Shiller’s book is: “The National Bestseller That Revolutionized the Way We Think About the Stock Market.” So it should not be a surprise to anyone that agreement with these ideas leads to the adoption of new strategies.

In fairness, this didn’t hit me either for a long time. I just kept drilling in different areas and then one day it hit me that the common thread was that everything I did was an attempt to identify strategic implications of Shiller’s findings. The reason this is controversial is that no one has done this before. People want to see it approved by experts before they go with it. Somebody needs to go first to get the ball rolling.

I do not have the ability to do research and have no interest in developing that ability. My aim is to be the journalist who tells the story of the shift to the new model and who explains to the typical middle-class investor what the research that
will be done means for him or her. I need to have people do the research so that I can demonstrate to readers that experts have signed off on all this.

It’s an exceedingly odd story. But that’s indeed where things stand, so far as I am able to figure all this out.

Rob

Related posts:

1. “When I Was Checking In At the Hotel, J.D. Roth Was Sitting Nearby With A Group Of People Talking And He Called Out To Me”
2. “I Definitely Need to Cite [You] as the Founder of Valuation-Informed Indexing…. Shiller Pointed Out the Predictive Power of P/E10 But Never Discussed How to Incorporate It Into Asset Allocation.”

Wade also reported that “as always, I will be reading all your links.” He said: “I definitely need to cite some of your work as the founder of VII, as I have not found anyone else who can lay claim to that.  Shiller pointed out the predictive power of PE10 but never discussed how to incorporate it into asset allocation, as far as I know.”

Related posts:

1. VII #29 — Valuation-Informed Indexing Is Not the Same Thing As Tactical Asset Allocation
2. “The Key Is Explaining That Value-Informed Indexing Is a Tool for Asset Allocation, Not Market Timing”

Wade:

It’s always nice to hear from you. I am doing fine. Thanks for your kind comments re the podcast. I haven’t looked at the linked paper but I will look at it shortly.

Please ask any questions that happen to come up. I may or may not be able to help with them. If I am not, you will be helping me by leading me to discover holes in my thinking. That’s obviously important.

Your interest in the general subject encourages me. As you know, I have been walking this path for a long time. I was pulled onto it not out of a personal desire but as the result of a strange set of circumstances. As I continued down the path, I discovered more and more tentative findings that seem to me to offer great promise. So I have not been able to give up the effort either to disprove or affirm the basic concept.

In ordinary circumstances, this would be easy to do. But my experience has been that even many smart and good people do not want to look too closely even at tentative findings that suggest follow-up findings so far removed from the conventional wisdom of our day. So I have been frustrated in my effort either to convince myself that the ideas are not worth pursuing or to convince enough others that they represent genuine advances  to get them the attention that they merit in the event that they are sound.

Any work you are able to do re these ideas will obviously help move the ball forward a bit. So I am happy that you are evidencing a good bit of interest. I will always be happy to help in any way I can whether that means that the ideas become better known or that they become discredited. The important thing is that the ideas either be advanced or killed based on the extent to which they do a good job of describing the realities.

Please take whatever time you need before moving to the next step in your explorations. It is clearly more important to get each step right than to move through many steps at a quick pace.

Thanks for bringing a measure of cheer and optimism to my Sunday morning!

Rob

Wade:

I pulled up the paper.

I only took a quick look because I recall that one coming up in a discussion that was held at the Vanguard Diehards board at the time the paper was published. My recollection is that this is the paper that prompted John Walter Russell to coin the term “idiot switching.” I haven’t spent enough time with the paper to refresh my memory re their methodology but my recollection is that they did not do things in the way in which someone trying to make the strategy work would do things. The put the non-stock money in unnecessarily low-earning asset classes and I believe that they often made extreme shifts (from very low stock allocations to very high stock allocations) in response to modest P/E10 changes (I am not even sure if they always used P/E10 — it may be that they were using P/E1, which is far less reliable). I recall not being impressed by that paper when it came out.

Rob

Wade:

I have two articles at my site that link to studies on the VII topic. As a journalist, I follow a broad interpretation of the word “study” (I am open to using anything that effectively makes the point). So it may be that these two articles will not be of value to you. But it is possible that one of the links or one of the excepts will lead you to something of use. So I thought I would pass these along.

http://www.passionsaving.com/buy-and-hold-is-dead-part-one.html

http://www.passionsaving.com/buy-and-hold-is-dead-part-two.html

Also, here is an article linking to 20 quotes that I collected making the essential point. I think it makes a compelling case to read all these comments in one place:

http://www.passionsaving.com/buy-and-hold-investing.html

Rob

Related posts:

1. “I Cite You and John Walter Russell as the Earliest Advocates of [New School SWR Research]“
2. “I’m Quite Encouraged…with John Russell’s Results”

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.”

Related posts:

1. Academic Researcher Wade Pfau: “Two Papers by FIsher and Statman Are Still All I Can Find That Provide Evidence Against Long-Term Market Timing”
2. VII #28 — Wade Pfau’s Research Understates the Superiority of Valuation-Informed Indexing Over Buy-and-Hold

Wade:

I obviously would love to see you use that title, Wade. And I think that would do a lot to move things in a positive direction.

As I am sure you understand, there are some delicate matters in play here. I am of course grateful for anything you are able to do to open things up and I will of course participate in a constructive way to the extent that it ever becomes possible to do so.

People are defensive and embarrassed (and even ashamed and even fearful of facing legal liabilities). I think that’s the true reason why there were so few views on your third thread. What usually happens in that a few of the regulars posts to a thread and then the far larger number of non-regulars feels comfortable joining in. In the case of that third thread, the regulars did not want this message being heard (because of the board’s history re this message). So they let the thread die. There was a day when every SWR thread got HUNDREDS of posts in that community.

It has never been my intention to make anyone feel bad. That community has huge potential. I have learned a great deal from lots of people there and I have lots of friends there who have said many kind thing about me and my work. The problem is that some have taken dogmatic positions and feel that they cannot back down no matter what. I believe that everyone should be expressing his or her sincere views, but “everyone” obviously includes me and the others who believe that valuations affect SWRs.

I believe that it will all get worked out in the end. The sooner that happens, the better it will be for every single person involved. But there are limits to what I can do to make good things happen. I need to wait for events to turn in a positive direction. When that happens, I will be doing all that I can to bring things to a better place for every single person involved.

Rob

Related posts:

1. The Economist Magazine Endorses New School Safe Withdrawal Rate Research
2. “Thousands of Experts Who Heard People Calling the Number Generated By the Study the “Safe Withdrawal Rate” Never Corrected the Record — Why?”

Wade:

It’s always good to hear from you. Things are going well with me.

I have read the book. My favorite part is the introduction. Stein there explains what got him started on the path that led to him writing the book. What got him started was the commonsense observation that timing just had to work — for timing not to work would mean that the price we pay for stocks makes no difference in the results that we obtain and that simply cannot be so.

This is a two-step process. First, one has to be persuaded that timing must work. Then one must go about finding the best approach to timing.

On the first question, I am persuaded that we know the right answer –we know that timing works because it is not possible for the rational human mind to imagine a universe in which the price paid for something does not matter. On the
second question, we need to explore lots of possibilities. It’s not possible for us to know anything with much confidence until there has been extensive public debate on numerous possibilities and we are just not there yet. To get that debate, we need to persuade the Buy-and-Holders to ease up on their dogmatism enough to permit a variety of viewpoints to be widely heard.

The focus on 1984 and 1985 is important. I think that the way the price signals work is indeed the flaw to their particular approach.

There is no one P/E10 level at which stocks turn good or bad. People need to understand that the value proposition gradually changes. Any cliff approach is going to fail in some circumstances.

Say that we were trying to say what the perfect highway driving speed is. Some would say “55,” some “60,” some “70.” Some would say “80″! And, if you tested this, you would find that sometimes driving 80 does not lead to an accident. And sometimes someone driving 55 gets in an accident. There is no one correct driving speed. It does not exist.

It does not follow that we should not have speed limits. We must have a speed limit. We know that the danger of driving increases as speed increases. So we just need to reach a consensus that it is okay to drive 65 but not 70 and go with that even though we understand that there is something artificial in setting the speed limit at any one particular number.

This is how it works with stocks. Stocks are more risky when the P/E10 is 15 than they are when the P/E10 is 10. And 20 is worse. And 25 is still worse. And 30 is still worse again. But there is no one magic number. If you say ”Sell all your stocks at 30,” you are going to be proven wrong in the eyes of some when the P/E10 continues up to 44, as it did in January 2000.

We need to separate out the things we know (stocks get increasingly risky as the P/E10 level gets higher) from the things we do not know (the precise P/E10 level at which people should sell stocks). What we really need is a change in the way we talk and think about stock investing. We need to become confident enough to make measured statements.

Buy-and-Hold is inherently dogmatic (it posits that there is never a need to make any allocation change). I think this dogmatism has its roots in fear. Investing is so important to us that we demand a level of precision in our pronouncements that it is impossible for us to achieve today. We need to just relax a bit, let in different viewpoints, and stop feeling a need to come up with perfect answers to every question (Buy-and-Hold does not do this, so we should not demand that alternatives to Buy-and-Hold do it either).

We will never come up with perfect answers. The reason why is that there are always two opposite sorts of factors affecting stock prices. There are economic factors, which are highly predictable. And there are emotional factors, which appear to be almost entirely unpredictable. To not make any predictions at all is foolish because the effect of the economic factors is predictable and being able to predict returns reduces risk while increasing return. But to make precise predictions is ALSO foolish because the emotional factors are almost entirely unpredictable and will cause precise predictions to fail regularly.

What we can do is to identify a RANGE of possible long-term returns and assign ROUGH probabilities to each point on the spectrum of possibilities. This is of HUGE value. The Return Predictor tells us that, for stocks bought when the P/E10 is 10, there is a 50 percent chance that you will be seeing a 10-year annualized return of greater than 10.7 percent real and that, for stocks bought when the P/E10 is 20, there is a 50 percent chance that you will be seeing a 10-year annualized return of less than 3.0 percent real. This tells us a lot about how much risk applies in these two different scenarios.

But it does not tell us everything. With a super good returns sequence, you could buy stocks at a P/E10 of 20 and get a 10-year annualized return of 9 percent real. With a super bad returns sequence, you could buy stocks at a P/E10 of 10 and get a 10-year annualized return of only 4.7 real.

No one knows in advance what returns sequence is going to come up. This is determined by investor emotion, which cannot be predicted. We should be making use of what we do know (that stocks carry more risk at higher valuations) while
not pretending that we can know things we cannot know (things that we would need to know to make precise predictions).  We CAN time the market, but only in the long-term and not in such a way as to permit precise knowledge of market
tops and bottoms.

Wade sent a brief response later that day expressing surprise re how few views there were at the Bogleheads board for a thread he put up on the effect of valuations on safe withdrawal rates and saying that, based on the research he was doing, he was giving consideration to going with the following title for his next thread-starter at the Bogleheads Forum: “Yes, Virginia, Valuation-Informed Indexing Works!”

Rob

Related posts:

1. Wade Pfau, Associate Professor of Economics at the National Graduate Institute for Policy Studies: Valuation-Informed Indexing Works
2. Academic Researcher Wade Pfau: “As You Say in Your Podcast, Valuation-Informed Indexing Should Beat Buy-and-Hold About 90 Percent of the Time, and I Am Getting Results That Support This”