The Invest It Wisely blog last week posted an article that is exciting for two reasons. One, it advocates Valuation-Inforemd Indexing. Two, it was not written by Rob Bennett!
This is the sort of thing we need to see to get the ideas we have been talking about and developing in the Retire Early and Indexing discussion-board communities for nine years now into the mainstream. We are beginning to see signs of what I have long dreamed of — a “Normalization” of our discussions of the realities of stock investing.
The article is by Mathieu Bouville and is titled The CAPE: How to Beat Stocks with a 50/50 Portfolio. It’s super stuff.
Juicy Excerpt: Figure 1 shows the annualized real return over the next 20 years as a function of the current CAPE. When the CAPE was below 10, the return of the S&P 500 has never been below 5% p.a. over the next 20 years (i.e. one at least multiplied one’s purchasing power by 2.7). And it has never been above 3% when the CAPE was above 23. (This does not mean that this will never happen, just that it is quite unlikely.) With the 1999–2000 CAPE of more than 40, it is hard to see how one could dream of making money in the long run…. If the CAPE has some predictive power, it can be used to improve the efficiency of one’s asset allocation.
This article is really funny. If everyone followed this strategy then they would all pull out of stocks at the same time, leaving an obvious buying opportunity for people _not_ following the strategy. Meanwhile the folks following the strategy would wait around for X amount of years and miss out (perhaps for a very very long time).
You are kinda, sorta on the right track. But the realities have not quite taken with you yet, What (no offense intended).
Buy-and-Holders often ask for precise rules for when allocation changes should be made. I always point out when they do this that it is artificial to pretend that there is some magic in going with one allocation at one P/E10 level and with a different allocation at a slightly higher P/E10 level. There is no magic.
The reality is that the risk of stocks gets slightly greater with each step up in the P/E10 level. There is indeed wonderful magic in giving up on Buy-and-Hold and accepting that you need to be making allocation changes from time to time. But there is no magic in any precise set of allocation changes that anyone will ever put forward.
Back in the real world, investors are not going to be following one author’s recommendations for when changes should be made. There are going to be dozens of different authors recommending dozens of slightly different rules for making allocation changes (just as there are today dozens of different authors recommending slightly different ways of choosing your allocation under Buy-and-Hold). The result is that ALL upward moves in P/E10 will cause stock sales and ALL downward moves in P/E10 will cause stock buys.
That’s as it should be, What. The value proposition of stocks is lower when prices are high. So in a rational market you MUST see sales as prices increase. When we achieve this state of affairs, we will have a rational, functioning market. We will also have an EFFICIENT market! Fama will be vindicated when Buy-and-Hold is overturned. It is the greatest paradox of our nine years of discussions.
Stock prices are naturally self-regulating, What. The only reason why we see overvaluation and undervaluation (mispricing) is because of our IGNORANCE of how stock investing works. With the publication of Shiller’s work and the 30 years of research now backing it up, that ignorance is dissipating. As investors become smarter and more rational, the market functions more effectively and we all become able to retire many years sooner, earning far higher returns at greatly reduced risk.
Human knowledge advances over time, What. This world is not a closed system where a benefit for one has to result in a detriment to another. Valuation-Informed Indexing is the biggest advance yet seen in the history of stock investing.
You should be happy! Please try to be happy about this. It is good stuff piled on top of good stuff piled on top of good stuff. There is no downside.
My best to you, old friend.
Rob
Everyone will never follow this strategy just as everyone does not follow buy and hold, even if they were carefully taught. Fear and greed will always be present, even among the educated, and those will always affect implementations.
But even if everyone followed VII, there would be different viable interpretations of it and different personal needs for risk based on age and numerous other preferences.
Rob promotes VII, but his particular circumstances have had him out of stocks for a long time. Similarly, my notion of how much stock to hold when at PE 24 may be different from another who still understands PE 24 is pricey territory. Someone in retirement who understand how all this works may still have an allocation different than a VII advocate who is but 25—because ten years is not the same for both.
Accepting that valuations matter—even if everyone did accept that— does not mean all implementations must necessarily be the same.
Thanks for adding those words, Arty.
Rob