Kay Conheady has posted a super article for the Advisor Perspectives site. It is titled Does the Trend Matter?
Kay was kind enough to include my name in a list of the people who have done the most to promote the Valuation-Informed Indexing concept. She wrote: “I am fascinated by the growing body of research that revolves around the P/E10 ratio (and its siblings, the P/E5, P/E15 and so on), also known as the cyclically adjusted or normalized P/E ratio. In the past 5 years there have been numerous articles published at Advisor Perspectives as well as independently and in professional journals by numerous researchers: Robert Shiller, Doug Short, Wade Pfau, Michael Kitces, John Hussman, Crestmont Research, Jim Otar, the team of Mike Philbrick and Adam Butler, Rob Bennett and others.” It brought a nice measure of cheer to my Tuesday afternoon to read those words.
Juicy Excerpt: The average annualized 10 year future return during P/E10 ratio downtrends is less than 1%! Downtrends would seem to pose substantial challenges even for long term investors. And, while average returns vary quite a bit between the trends (Figure 2), standard deviation doesn’t which leads to quite divergent Sharpe Ratios (Figure 3)! It seems fair to say that 3, 5 and 10 year risk adjusted future returns tend to be quite a bit higher (as do absolute returns) during uptrends versus down trends!
Good to see more talk on Shiller and PE/10. Nice mention on you.
I think this article, though, is a move toward complexity and not necessarily the sort that will enhance returns (in fact, the reverse is often true). I know Sortino Ratios and all that have their place but it seems too smart by half.
I’m grateful to you for sharing your thoughts, Arty.
I certainly am not in favor of any unnecessary complexity. Kay is talking to a sophisticated readership here (the site is aimed at financial planners). So, to some extent, I think we need to understand that that’s the language they speak. There are dangers in getting too fancy, to be sure. But there might be some in that group that will be impressed to see what the statistical tools say.
My take is that the article did something important that I have not seen done before. I have had many people ask me to identify the proper stock allocation to go with each of the P/E10 levels. I always beg off on doing this because I don’t think it can be done.
One of the reasons is the factor being pointed to in the article. P/E10 levels do not pop up randomly. They appear as part of an up trend or as down trend. Where you are on the trend line makes a big difference. A P/E10 of 21 on the way down (where we are today) is very different from a P/E10 of 21 on the way up (where we were in the early 1990s).
This suggests another very important question — WHY do P/E10 levels appear as part of a trend line? Why are they not random? To have confidence that P/E10 levels are going to continue to affect long-term returns, we need to know the answer to that question. Not much has been written about it. We need to see a lot more exploration of that sort of point, in my assessment.
Many people seem to have the idea that P/E10 is a new element of our understanding of how stocks work that we can add to the model we use today. This is not so. If valuations affect long-term returns, today’s model is discredited all the way down to its foundation. We need to build a completely new model.
So we need to ask these basic questions. People have long thought that it is economic developments that determine stock price changes. It now appears that that is not so. It is primarily investor emotions that determine stock price changes. That changes everything. There are all sorts of implications that follow from that.
For example, if it is investor emotion that determines stock price changes, a big bull market would be sure to cause an economic crisis (because all bull markets end, and the end would cause negative investor emotions and the negative investor emotions would cause a huge loss of buying power in the economy).
We have spent the first three years of the economic crisis talking about a lot of nonsense. We should have been talking about the devastating damage done to our economy through the promotion of Buy-and-Hold investing strategies.
Kay is not saying these things directly. But her focus on the trend line (rather than on the P/E10 level itself) suggests exploration of them. It is my view that she has advanced the ball in a significant way.
Rob
Good explication. And yes, nice to see PE/10 getting into the places it can make big differences—the money managers.
Still, I would say that advisors (those who profess *most knowing*) are the most vulnerable to these sorts of complexities. Part of the reason is that they believe they can’t sell “simple.” Part is because they actually believe this other stuff, which has portions of truth, but far less real life impact than the complexities suggest.
I agree, Arty.
“Experts” want people to believe that there is a need for “expertise.”
Investing well enough to be able to finance a middle-class retirement by age 65 is a pretty darn simple business. To make money by giving advice about it, you need to muck everything up with lots of big words and fancy graphics.
My sense is that a lot of money managers want to make a switch to Valuation-Informed Indexing. Buy-and-Hold isn’t selling so well anymore and they want to be the first on the block to push the new thing.
The trouble is — how do you make the transition? If you point out the dangers of Buy-and-Hold, you get all the “experts” who haven’t made the transition yet mad at you. And it’s pretty darn hard to persuade people to follow VII without pointing out the dangers of Buy-and-Hold given that the two are rooted in opposite premises. So we are at a bit of a standoff for now.
The driving considerations are marketing considerations. That’s what is holding everything back. We need a big name who is willing just to report honestly and accurately what the research says and not back down in the face of personal attacks. In theory, it should be the academics who would fill that role. For reasons I don’t entirely understand, not enough academics have stepped forward.
Even Shiller pulls his punches. Shiller is obviously a hero of mine. But I don’t think it can be denied that he should be pushing a lot harder than he is, given the stakes that apply if we do not soon get serious about doing something about this economic crisis.
Rob
Shiller pulls punches and also sends mixed and contrary signals, if you follow all his appearances. This is especially true on the question of what he was doing in March, 2009 (he said he was waiting for a lower PE—like PE/10—and then later said he was “in”). Still, he is the lead figure in this.
Here’s the deal with the academics: Part of the reason the academics aren’t on board has to do with Fama’s work on the 3-Factor Model. I’ve looked at this a lot. 3-Factor posits greater explanatory power than CAPM (the S&P, say), and so all sorts of sub-classes of academics and advisors get caught up trying to analyze precisely what is going on with Small and Value asset classes (since they had the supposed outsized returns). Indeed, companies like DFA (using Fama as a principal and researcher) have exploited this to the nines.
Thus, the advisors use this to SELL outperformance to the mob (nobody is selling just the S&P 500, see?!).
The academics primarily want to get published and just seek fertile ground to explore. As the extra risks of Small and Value have not been definitely explained (even Fama says that is so), there is a lot of work centered on explaining them in professional papers.
Now, to acquire those extra expected returns, a buy-and-hold approach is necessary because one can go years before they pay-off. So, this keeps a lot of the attention focused on those asset classes and that strategy for using them, which must is buy and hold (unless one is a very active, short-term, market timer).
All that you say makes sense, Arty. I don’t doubt that this is all so.
There is one thing that makes me absolutely crazy, though. Shiller’s book was a bestseller and was widely reviewed. So lots of people accept that there’s something important going on in that book.
The subtitle describes the book as “revolutionary.” So the something that is going on is obviously something new, something different.
There is not one major blog or web site that explores that something new and different in any depth! This makes my brain explode.
Shiller never says in his book how people should set their allocations! How can he write an entire book on stock investing and not do that?
And no one to this day (other than myself) has picked up the ball and done this? Why not? There’s huge amounts of money to be made helping people with this stuff. There’s huge amounts of fame to be won. Why does no one want the money and fame?
Seriously, this one makes me crazy. I sometimes feel that we are all under some sort of spell.
Why don’t people at least talk about it? Why don’t people say, “well, the people who are at 80 percent stocks under Bogle would be at 20 percent stocks under Shiller” or whatever?
All the grief I get is because I am saying something no one else has said. And I don’t really want to do that. I would prefer to have other people saying it. But it’s like pulling teeth to get people to address these basic and obvious questions.
What am I missing? Are we really under a spell? Is it all going to change on a dime someday?
Rob
Revolutions are…difficult!
Rob wrote: “And no one to this day (other than myself) has picked up the ball and done this? Why not? There’s huge amounts of money to be made helping people with this stuff. There’s huge amounts of fame to be won. Why does no one want the money and fame?”
——
Several points. Shiller’s work can impel a belief system. But there are other belief systems that may seem to be (certainly marketed as being) more attractive. CNBC is all about what are you doing NOW. And you must DO something. This generates tons of revenue via churning. Advisors are about something else—continual AUM fees—but this too can be quite profitable.
What advantage is there in NOT doing what you suggest? It would make these types less money.
Now, academics are a different story. They make little (comparatively, unless part of a product, like Fama), and so their “coin” comes via publishing, slaughtering sacred cows if possible, or offering fresh insights—explanatory power. And thus getting “fame”, as you say. But, academics focus on what they think “sells” to the fame issue, which as I mentioned above, is often other issues. But maybe that will change.
Revolutions are…difficult!
Thanks much for the humor. That’s what is needed here more than anything else!
Rob
Re the rest, all of what you say sounds right to me.
I have a quote from Machiavelli set forth near the bottom of the “People Are Talking” section:
“There is nothing more difficult to plan, more doubtful of success, nor more dangerous to manage than a new system. For the initiator has the enmity of all who would profit by the preservation of the old institution and merely lukewarm defenders in those who gain by the new ones.”
It offers some comfort to know that this sort of thing has been going on among the humans for as long as there have been humans.
So humor is key. And kindness. And good cheer.
And stubbornness! (When it comes to the matter of defending one’s right to report numbers accurately and honestly).
And one morning we will all awaken to find ourselves living on the other side of the Big Black Mountain. In peace and harmony.
With visions of early retirements dancing in our heads!
Rob
You raised a number of good points there. And yes, we can look to the deep past and draw relevance.
I agree with Machiavelli on the difficulty of new systems. Now the one exception is where the old system is broken. This can be in many fields. The Germans lost WW-1, and had harsh terms put upon them. Their military was crushed. So, they created a new one that actually dynamically overturned the old (French/Brits), and then thankfully they lost due to superior allied numbers! Same for Napoleon—new (modern) system replacing an antiquated one.
Humor matters.
On stubborness, I agree it is necessary when one has identified the problem. Using history, were it not for stubborness—orneriness even—one can think of the many horrific things that might still endure in mankind, or the great advances that would be halted, were it not for certain stubborn intents.
Now, to the present relevant context, rhetoric is the main tool (with use of data as logical evidence). And I’m all for doggedness, stubborness there. But as we are dealing with humans, I have come to learn the way argument is presented, with all that such implies (tone, relative brevity, etc.), has at least as much sway, maybe moreso, than a well-argued position. This is tricky, but for starters, one must be aware that it is true. On Spock’s Vulcan, that would not be so. But here, it is.
But as we are dealing with humans, I have come to learn the way argument is presented, with all that such implies (tone, relative brevity, etc.), has at least as much sway, maybe moreso, than a well-argued position. This is tricky, but for starters, one must be aware that it is true. On Spock’s Vulcan, that would not be so. But here, it is.
I’m grateful to you for putting forward these words, Arty.
I agree 100 percent with what you are saying. I have zero aspirations to being Vulcan-like. I am keenly aware of the emotional dynamic being played out here.
I know that you (and a good number of other people for whom I feel considerable respect) believe that I don’t always say things in the most effective and constructive way. If I could see it, I would change my approach. I sincerely cannot see it.
I will ponder it. I will try to see what I cannot today see. I cannot promise that I will ever get there. But I can say in sincerity that I want to be open to hearing the other point of view.
Please don’t hold back from trying to steer me in the direction that you think would work better, to the extent you are willing to devote your energies to doing so. I need help and lots of others need help. So efforts along those lines should be respected and admired and encouraged.
I will argue my side of things if words along those lines show up here. Not because I want to be argumentative. Because to come to a better understanding of the other point of view, I need to have both points of view out there interacting with each other.
John Walter Russell did more than any other human being alive to advance the cause of Valuation-Informed Indexing. He spent eight years of his life working on it full time without receiving a dime of compensation in return. John felt at times as you do, that I pushed too hard.
I never was able to appreciate what he was getting at. I respected him greatly. I admired him greatly. I liked him greatly. I know with 100 percent certainty that he was proceeding with good intent. There’s just something in my background or personality or knowledge base or something that thus far has made it impossible for me to appreciate the point when it comes to specifics.
I AGREE with the point as a general proposition. Logic is not the hang-up for me. I care more about people’s feelings than I do for logic chains.
I think it has more to do with me being a journalist. I have an intense love for learning achieved through communication. To me, the greatest horror in the world is deliberate ignorance. Heaven to me is always learning new things and hell is losing through one’s own choices the ability to learn new things.
So I think the divider for me is being able to talk things over in a spirit of mutual respect and friendship. It doesn’t bother me even a tiny bit that the Buy-and-Holders don’t agree with me on investing topics. I like them as people and their views on investing just don’t enter into my assessments of them as people. But I am not able to participate in discussions in which I am not doing my best to help people learn. When I stop doing that, I cannot write another word. Helping people learn is the driver for all I do. If I give up hope of doing that, I don’t know that I’ll be able to get out of bed the next morning.
So asking me not to say what I believe is for me like asking me not to breath. I am not capable of it. Or at least that’s how I see things today.
There was a long period of time when John continued posting at The Safe Withdrawal Rate Research Group after I had been banned there. He was producing wonderful work that I am sure played a positive role. But he kept quiet about the ban. I would not have been capable of doing that. And I did not approve of his way of handling things.
I respected him. I acknowledge that his approach produced something positive. But I cannot imagine how I would have been able to do that. If he had been banned, I would have complained about the ban every day until either it was lifted or I was banned too.
I tell that story to give you a sense of where I am coming from. I get the point about presenting things in a way that helps people hear the message. But I cannot fail to speak up when someone pushes a retirement study that gets the numbers wrong. It’s just too horrible! I remember the fears that I had when I handed in my resignation and cannot bear the thought of participating in a process that causes failed retirements for other people.
Anyway, that’s where I am coming from, for better or worse. Thanks again for trying to do some good.
I AM capable of stubbornness. My father once told me that I am like steel when I think I am right. It is rare for me to make a big deal of something. My nature is to go along to get along. But when I am 100 percent sure I am right about something that seems to me to be of huge importance, I feel that I am being unfaithful to everything that life is about (not just my life, ALL life) to betray the truth that I am trying to advance.
Others don’t seem to see it that way. I am using the word “I” here. I am to the best of my ability reporting how I see it.
Rob
I hear you.
Understand that I am in no way talking about compromising who you are. I certainly don’t want to see less stubborness per se. After all, if a basic problem still exists, one can feel that he must continue to point it out.
And while I do have some disagreement with the content of your views, in the main I agree with you re: valuations and related points—the “how you see it”.
Re: John R., it seems you and he had differences in the way you “attacked” identical problems (or chose not to). Nothing wrong with that and perhaps made for a good team.
I view this—effective communication (or whatever one wants to call it) as a sort of “fighting tactics”. This isn’t about being combative, per se (though it can be). That is, given that you (“you” meaning anyone) want to make change via persuasive argument, one fair question becomes how best to achieve that via the tools in your writer’s craftbox? Or how is a fair message, in which you have great passion and intent, best posed so as to be more likely *heard*? I’m not talking vocabulary or grammar here, of course.
And it is particularly when we are about something emotionally powerful in us that we need to both honor that—and take care of the reader. I think you’re the right guy for this on this topic.
And I’m also saying that you (meaning anyone) can still firmly “advance the truth” you believe but I would suggest looking for good criticism on how best to do that and things to avoid doing altogether. In many cases less is more (I hate that but I’ve not time to say it better)! This is obviously a more suitable discussion with friends in private, but still.
Thanks for your feedback, Arty.
I’ll talk strategy.
I think the problem is that the number of people who see the problem with Buy-and-Hold is too small. I think there is a tipping point at which new ideas come to win converts and then support for them grows rapidly. Until they get to that tipping point, progress can be very slow. There are always people open to the new ideas. But for so long as the number who believes in the idea is so small that not many dare to speak out, the idea never gains momentum and those with a possible interest in it don’t know even to ask about it.
Say that we were talking about the question of the slaves being freed. My guess is that there were always people who thought this was the thing that should be done. But the issue was a highly sensitive one and so just about nobody spoke up. So long as that remained the case, the idea of the slaves being freed never gained momentum.
At some point, something caused a small number to speak up. Once that number reached the tipping point, things took off. That’s what I think is going to happen here.
I think there are lots of bloggers who would love to write about this stuff but worry that they will be challenged if they do so. I think there are lots of researcher who would love to investigate new questions but worry that they will fail peer review if they question the dominant model. There are all sorts of things that will happen once people are assured that there will be no penalty for expressing a view that Buy-and-Hold is dangerous.
People follow social signals. People don’t want to be outliers. Once the idea that Buy-and-Hold is dangerous is supported by 10 percent of the population (or whatever the number is), the idea will take off and spread like crazy. But until we get to that point, there is a social stigma attached to the idea that blocks its growth.
The rub is — how do we get to the tipping point?
I think we need to demand (not ask!) respect for our right to post our sincere views. Once that right is respected, more and more people will ask questions about Buy-and-Hold. Over time, they will come to see the problems. And opposition will grow.
So I put a great deal of emphasis on this point that we must be permitted to post honestly. I think we should be 100 percent kind and polite and warm towards those who disagree. But I also think that we should be uncompromising on the issue of being permitted to post honestly. It is only by permitting honest posting that we open our communities up to the possibility of learning new things.
Again, that’s just where one particular community member is coming from. For me, the magic day will be the one in which as a community we come to believe that we all have a right to post our honest views. There will still be only a small number of Valuation-Informed Indexers on that day. But on that day we will have achieved the breakthrough we need to achieve for everything to change over time. On that day we will have in place a process that will ultimately get us to where we all ultimately want to be.
Rob
I wonder how much weight these investment boards really carry with mainstream Americans, vs. other venues (like the news, or best selling books)? See, for folks who examine specific venues closely (say, those boards), it might be easy to view that world as having more outreach than it does. Of course, what I am hypothesizing is true for other fields and subjects that in turn have their own boards.
But as you mentioned, even Shiller’s best seller has not yet changed things a lot—though it did enable some change and added work.
Now look at this recent article on a “Larry Swedroe strategy” in the TIMES:
http://bucks.blogs.nytimes.com/2011/12/23/the-search-for-a-low-risk-high-return-portfolio/
This could have been on any topic or strategy but I wonder how many ordinary folks will be reading that piece vs. visiting any investment board?
We need to have this stuff reported on the front page of the New York Times, Arty. There’s no question about it.
Getting the boards opened up to honest posting is a step toward achieving that goal. I’ll give some examples of how this works.
I first wrote to Scott Burns in February 2005. He expressed interest in writing an article about the errors in the Old School SWR studies. He ended up getting cold feet and he only made mention of this in a column he posted in June 2005.
Say that I had been successful in persuading him to write a full article or a series of articles and that he had been able to persuade his editor that the series belonged on the front page of the Dallas Morning News. There’s a good chance that someone from the NY Times would have seen it and then the NY Times would have written their own series.
That’s how it is done. The hard part is getting the fire started. Once it gets started, it builds on its own. I only knew about Scott’s interest in SWRs because of his association with Greaney, which I learned about from the boards. So, yes, the boards can play a big positive role.
Wade Pfau has published some amazing research. An argument can be made that in time his research will be viewed as being more important than Shiller’s research. Wade has told me that he first became interested in the New School SWR research as a result of reading my posts at the Vanguard Diehards board. That led him to doing research on SWRs and the SWR research led him to doing research on stock allocations and that sort of thing. One thing leads to another.
I announced in 2007 that I would be asking Bogle questions at the annual Bogleheads meeting. Say that the product of that meeting had been an announcement by Bogle that he now realizes that Buy-and-Hold is a terribly flawed and dangerous strategy and that we all need to move in the direction of Valuation-Informed Indexing. That would have been huge.
The Lindaurheads and the Greaney Goons get this. That’s why they fight so hard. They understand that, if we permit honest posting on a single subject (SWRs), the idea is going to spread and soon we will be having honest discussions about all sorts of important topics. It will grow and grow. That’s why they want to block things as soon as they see any interest in the community of permitting honest posting.
Shiller published his research in 1981. There are reasons why it has been bottled up for so long. There are lots of people who have made lots of money promoting Get RIch Quick strategies. The beauty of the boards is that most of the people who participate on the boards are not in the pocket of The Stock-Selling Industry. We can shoot straight with people if we have done our homework and know what we are talking about. You don’t see that in newspaper articles because the newspapers get their money from advertising by The Stock-Selling Industry.
But you WILL see the newspapers telling the straight story if we put pressure on them. The internet offers us an opportunity to keep the middle-class from going under. Once we get enough middle-class investors informed about the realities, the newspapers and magazines and all the rest are going to have no choice but to report the realities. The boards are the place where we get things started.
Once people know the realities, there obviously is never going to be any interest in going back to Buy-and-Hold. Buy-and-Hold is a mistake. It hasn’t been corrected because the “experts” in this field are too proud to admit a mistake and because for a time there was so much money in Get Rich Quick. But there are more people getting worried about the economic crisis every day. So Buy-and-Hold is going to be going under in any event. The boards give us a means to make sure it goes under before it brings the entire U.S. economy down with it.
The boards can have a HUGE positive influence. But, without integrity, no board is worth two cents. This battle is a battle to win our right to post with integrity.
Rob
Perhaps the boards are more important that I believe, or that they can impel important things if views are sustained long enough. After all, the “Larry Strategy” (linked above) has been discussed on the boards quite some time, but only now in mainstream, and that is due to some journalist trolling the boards. (Trolling to acquire material, that is, like a fisherman!).
Yes.
Boards are a fantastic place to test ideas. One, you get affirmation from people thinking along similar lines. That can help you sharpen an idea or take it to new places. Two, you get criticism from people not thinking along similar lines. That helps you fix things until you get it right.
We all learn by talking out loud and by tapping into other people’s thinking processes. Boards facilitate learning.
Have you ever looked at John Walter Russell’s site? There’s incredible stuff there. Every word is the product of things John learned from the boards. He had no idea of doing investing research when he retired. He saw the huge interest that people at the Motley Fool board had in learning the realities of safe withdrawal rates and he just took it from there. He got lots of feedback when he posted draft versions of his research at the FIRE board and at the SWR Research Group.
And how about the five calculators at my site? I couldn’t have produced any of those by myself. They are all the product of board interactions. I learned from discussions what people needed to invest more effectively. So the concepts for the calculators were the fruit of board discussions. And I met people who could help me with the statistical work on the boards. No one person can put all the pieces together. On the boards, we have people with all different sorts of perspectives and all different sorts of skill sets.
The internet discussion board is a powerful communications medium of the future, in my assessment. I think that one of the problems we are facing is that people are finding it hard to accept how much we have learned through the Retire Early and Indexing boards. People with old ideas have always resisted change. But, with the creation of discussion boards, we now have the means to learn in five years what would have taken 50 years in pre-internet days.
The attacks on our boards are just an effort to hold back progress so that people who have come to think of themselves as Big Shots can continue to bask in the fake glory that they can hold onto for so long as they keep others from learning things they very much need to and want to learn. Bah! Humbug! to that!
Rob
Here’s a new study discussing expected returns. Though, given the current PE/10 of 21, one could have arrived at a similar conclusion (or lower).
Happy Holidays to you and yours, Rob.
—
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1364520
The Expected Real Return to Equity
Missaka Warusawitharana
Board of Governors of the Federal Reserve System
December 27, 2010
Abstract:
The expected return to equity – typically measured as a historical average – is a key variable in the decision making of investors. A recent literature based on analysts forecasts and practitioner surveys finds estimates of expected returns that are sometimes much lower than historical averages.
This study presents a novel method that estimates the expected return to equity using using only observable data. The method builds on a present value relationship that links dividends, earnings, and investment to market values via expected returns.
Given a model that captures this relationship, one can infer the expected return. Using this method, the estimated expected real return to equity ranges from 4 to 5.5 percent. Furthermore, the analysis indicates that expected returns have declined by about 2 percentage points over the past forty years. These results indicate that future returns to equity may be lower than past realized returns.
Happy holidays to you and yours too, Arty.
Thanks so much for all your efforts to help out around here.
Rob