Michael Kitces has written a fine article on Valuation-Informed Indexing and the New School of Safe-Withdrawal-Rate analysis. It is called Shiller CAPE Market Valuation: Terrible for Market Timing, But Valuable for Long-Term Retirement Planning.
Juicy Excerpt #1: Nonetheless, the reality is that while Shiller CAPE has little predictive value in the short term, its correlation to market returns is far stronger over longer time periods; Shiller CAPE shows its strongest correlation to nominal returns over an 8-year time horizon, and is actually most predictive of real returns over an *18* year time horizon… supporting Benjamin Graham’s old adage that the markets may be a voting machine in the short run, but they are ultimately a weighing machine in the long run as valuation eventually takes hold. On the other hand, over very long time horizons (e.g., 30 years) Shiller CAPE once again begins to lose its value as other longer-term structural market factors take hold.
Juicy Excerpt #2: Prior research from the May 2008 issue of “The Kitces Report” has shown that Shiller CAPE ratios have an astonishingly strong -0.74 correlation to safe withdrawal rates and can help predict a reasonable starting point for retirement spending; because the long-term sustainability of retirement spending is most sensitive to an unfavorable sequence of returns in the first half of retirement, Shiller CAPE’s predictive value aligns quite well and helps to provide valuable insight about whether the prospective retiree faces an important headwind or tailwind in the early years of retirement. Notably, the results indicate Shiller CAPE is more correlated to safe withdrawal rates than it is to market returns themselves!
Juicy Excerpt #3: Perhaps this distinction between valuation’s long-run-but-not-short-run predictive value was the very reason the Nobel Prize committee gave its award jointly to Shiller for his work on how stock returns can be predicted in the long run, while simultaneously giving it to Eugene Fama for his efficient markets research showing that stock returns cannot be effectively predicted in the short run!
Rob’s Comment: Thanks for writing the fine article, Michael. It is important and brave stuff. I don’t agree when you suggest in the headline that P/E10 is not a good tool for long-term market timing. I certainly agree that short-term timing doesn’t work. But there is now 33 years of peer-reviewed research showing that long-term timing ALWAYS works and it is important for people to know that. I understand why you don’t want to say openly that long-term timing always works. It upsets Buy-and-Holders when they hear that. But that is the case and it is a very, very big deal. The research that I did with Wade Pfau shows that investors can reduce the risk of stock investing by nearly 70 percent by giving up on Buy-and-Hold strategies and engaging in long-term timing instead. That’s a very big deal indeed.
The most interesting thing about the article is that the model loses predictive value going out towards 30 years and is strongest at 8 years.
It is also interesting to note that Rob’s choice to forgo stocks was about 20 years ago, meaning that structural changes in the market can be affecting long term P/E ratios. Very scary stuff for VII adherents.
That’s not so, Laugh.
If Valuation-Informed Indexing is real, it SHOULD lose predictive power at 30 years. If we didn’t see that, we would have reason to have doubts about the model.
The peer-reviewed research shows that stock valuations do not go up or down in a random-walk pattern. They go up steadily for many years (perhaps 20 years) and then go down steadily for many years (perhaps 15 years). If you are at very high valuations, you should expect high predictability 8 years out because the market is close to crashing.
If you are at high valuations, you should NOT expect high predictability 30 years out. The market is close to crashing in that scenario. So you will get high predictability eight years out. But after the passage of 30 years, you will not only see the crash but also the recovery from the crash and the new bull market. The insane gains of that bull market will cancel out the insane losses of the crash years.
I am not entirely sure what you mean when you say that structural changes in the market are affecting long-term P/E ratios. I think what you are saying is that we may be seeing changes in the way the market operates. That could be. There is nothing “scary” about that. The research doesn’t tell us what will happen in the future, it tells us what happened in the past. We should learn from the research how the market operated in the past. Then we should learn about any changes that evidence themselves and factor those in to our knowledge base. There is nothing particularly “scary” about it. That’s how learning experiences work in every other field of human endeavor.
We are better able to face up to any changes if we are building on a base of good knowledge. If we are building on a base of fantasies (as are those who are living in denial re the last 34 years of peer-reviewed research findings), we are worse off. Those are the ones who should be scared. And, indeed, it is the Buy-and-Holders who on a daily basis evidence fear in the comments that they put to our boards and blogs.
Those are my sincere thoughts re these terribly important matters, in any event.
I naturally wish you the best of luck in all your future life endeavors regardless of what investing strategies you elect to follow.
Rob
Um, what is scary about it is you made a choice 20 years ago and the metric you used to make that choice has lost almost all of its predictive power by now – and you are still stuck on a low return portfolio.
If that isn’t scary I don’t know what is. The amount of faith/courage/stomach it would take a rational person to do that is beyond almost everyone.
Structural changes in the market are the variety of things that have happened (e.g. GAAP accounting changes, tax changes that favor buy backs instead of dividends, etc) that drive up P/E as a metric. The P/E you are comparing now is not apples to apples, further clouding the valuation and decision making.
In other words, that P/E of 8 might actually have been a much bigger 1996 equivalent P/E of 5 opportunity that you missed.
“I think what you are saying is that we may be seeing changes in the way the market operates. That could be. There is nothing “scary” about that.”
Huh? That undercuts the entire premise of VII. “Long term timing ALWAYS works”, your calculators, your prediction for a 65% drop. All depend on the future looking very much like the past.
Huh? That undercuts the entire premise of VII. “Long term timing ALWAYS works”, your calculators, your prediction for a 65% drop. All depend on the future looking very much like the past.
The idea that we should look at what has always happened in the past to gain an idea of what may happen in the future is not an idea that was advanced by Rob Bennett or by Robert Shiller, X. It was an idea that was advanced by Jack Bogle. This is not an idea that is advanced only by Valuation-Informed Indexers. It is an idea that is advanced by Buy-and-Holders. We don’t have a difference of opinion re this idea. We are united re this idea.
The only difference is that we parted ways in 1981. Peer-reviewed research was published in that year that showed that a correction was needed in the Buy-and-Hold Model. The Valuation-Informed Indexers made the correction. The Buy-and-Holders continued down the old, discredited road that they had been on since 1965.
Now you are saying that things may have changed.
I don’t see any evidence of that. Everything I see fits the model that was built on the research from 1965 through 1981 AND the research from 1981 through 2015. So I am not “scared” at this moment as to whether using the peer-reviewed research in this field is a good idea or not.
I don’t deny that it is possible that something has changed. That is ALWAYS a possibility. That didn’t become a possibility in 1981. That was a possibility in 1965. And in 1973. And in 1978. And on an on.
What of it.
If we learn at some point in the future that something has changed, we will obviously need to make adjustments to the model. Is there some reason why we wouldn’t want to do that.
Is there some reason to believe that the changes you are imagining will in some way favor Buy-and-Hold over Valuation-Informed Indexing? The odds are just as good that they will make Valuation-Informed Indexing even more superior than it appears to be today. Is that not so?
We cannot invest today based on future events that we imagine might someday take place. We have to invest today based on what we know today. All the research we have available to us today supports Valuation-Informed Indexing, none of it supports Buy-and-Hold. If that ever changes, we will obviously change our beliefs about how stock investing works. If we are a rational people, we have no choice.
But it does not make sense to make changes until we see some need for them. It doesn’t make even a tiny bit of sense to do something like that. That one is not a close call.
Is it “scary” to know that there is always the possibility that we will know tomorrow more about how stock investing works than we do today? I don’t find it even a tiny bit scary. I find it EXCITING. I find it WONDERFUL. I wouldn’t have it any other way.
If new research comes in showing that Buy-and-Hold is even worse than we understand it to be today, I will be shouting from the rooftops about that research tomorrow. I will be telling all my friends and neighbors and co-workers and fellow community members the exciting news.
If new research comes in showing that Buy-and-Hold is better than we understand it to be today, I will be shouting THAT from the rooftops. Why the heck wouldn’t I be doing so? What would be the downside of doing so?
I would LOVE to have some research available to me showing that Buy-and-Hold might work for one or two long-term investors. If I could talk about pro-Buy-and-Hold research as well as about the 34 years of peer-reviewed research showing the the pure Get Rich Quick approach never works, you Goons would calm down a bit. That would be a very good thing for every single person living on this planet. No?
I HOPE we find some research supporting Buy-and-Hold someday. I don’t expect it to happen. But I certainly would LIKE to see it happen. There is nothing even a tiny bit scary about the possibility. It would be the best thing that could happen, in my assessment.
Rob
Um, what is scary about it is you made a choice 20 years ago and the metric you used to make that choice has lost almost all of its predictive power by now – and you are still stuck on a low return portfolio.
If that isn’t scary I don’t know what is. The amount of faith/courage/stomach it would take a rational person to do that is beyond almost everyone.
Structural changes in the market are the variety of things that have happened (e.g. GAAP accounting changes, tax changes that favor buy backs instead of dividends, etc) that drive up P/E as a metric. The P/E you are comparing now is not apples to apples, further clouding the valuation and decision making.
In other words, that P/E of 8 might actually have been a much bigger 1996 equivalent P/E of 5 opportunity that you missed.
The one part of what you say above that I kinda, sorta agree with are these words: “The amount of faith/courage/stomach it would take a rational person to do that is beyond almost everyone.”
I don’t entirely agree even with that. If we permitted honest posting re the last 34 years of peer-reviewed research at every board and blog on the internet, I believe that every virtually every investor would be following Valuation-Informed Indexing today. There might be a few hold-outs. But I believe that the vast majority would have made the switch sometime over the course of the past 34 years had regular procedures been followed.
Now —
What you are saying really is true for most of today’s investors.
If I go to a board or blog and say “I have been at zero stocks for nearly 20 years, the vast majority of people who hear those words think that I must be a little bit crazy. They view it as an extreme position. They don’t want to follow investing advice put forward by someone who would behave in that manner, so far removed from the social norms that all the rest of us follow. That much really is so.
Let’s forget you Goons for a moment. Let’s look at someone like the author of the Joe Taxpayer blog. Joe is a friend. Joe finds value in the work I have done in this area. Joe thinks that every ban should be lifted and has said so publicly. Joe is as close to being a supporter of my investing ideas as there is on this planet.
Yet Joe is not really a supporter.
I have never asked Joe what his stock allocation is. But my impression is that it is not the 30 percent stocks that I recommend. My guess is that it is a bit lower than the 74 percent that John Greaney says is always “optimal.” But it is probably more than 30 percent stocks. So my greatest supporter is only kinda, sorta, maybe a supporter. I can give you that much, Laugh.
That doesn’t show that the ideas are wrong.
What it shows that there is some force in this world that makes the ideas temporarily unpopular.
Anyone who is familiar with Shiller’s research knows what that force is.
It is INVESTOR EMOTION.
Emotion influences all of us. It influences you. It influences me. It influences. Shiller. It influences Bogle. It influences Joe.
Investor emotion explains everything that we have seen on the boards and blogs. And investor emotion explains everything that we have seen in the markets.
You are suggesting that the Valuation-Informed Indexing Model might have problems. IT MIGHT. I am not saying different. I am not God. I have gotten things wrong before. It could be that it is happening again. If it were, I would probably be the last to know. So we are in agreement.
Next you say that I should be “scared” about this possibility that I am wrong.
I am not.
You know why?
I know that there are lots of people in this world who are going to promote Buy-and-Hold if I am wrong. I know you Goons (plus lots of non-Goons) have that one covered. So there is nothing to be scared about.
I guess you are suggesting that I will be hurt personally if Valuation-Informed Indexing is wrong. That is so. So, yes, to that extent I guess I should be scared.
But the same exact thing is true for you and for all other Buy-and-Holders. It could be that it is Buy-and-Hold that is the thing that is wrong. In that event, you will be hurt. So we both should be equally scared.
It seems to me that the evidence is overwhelming that you are more scared than I am. I have never threatened to kill anyone. I have never demanded unjustified board bannings. I have never advanced tens of thousands of acts of defamation. I have never threatened to get any academic researchers fired. I have never committed felonies. You are the one who is scared here, not me, Laugh.
There is a sense in which you are hitting on a very important point.
As a society we are in a primitive state of understanding how stock investing works.
Any of us could be wrong about anything we say. So, yes, we ALL should be a little bit scared that we have gotten something wrong.
That should make us careful about being too dogmatic in our statements. But things have played out just the opposite. The Buy-and-Holders have become INSANELY dogmatic.
Why?
Because they are scared. Their fear of being wrong should make them humble. But one way that humans react to fears of being wrong is to play it just the opposite, to whistle past the graveyard, to act more confident than they feel.
That’s you, Laugh.
That’s ALL the Buy-and-Holders.
You are the ones who are scared. You are scared that you have destroyed millions of middle-class lives. You are scared that you caused the biggest economic crisis in U.S. history. You are scared that you are going to prison following the next price crash.
I am a little scared that I got things wrong and that I have hurt myself personally. But that is nothing compared to how scared you are that you caused more human misery than has ever before been caused in the personal finance realm.
Humans are vulnerable creatures. We are always going to be somewhat scared about something. There is no getting around it.
The laws of our country keep these fears from getting out of hand. When we permit the other guy to have his say, the fears can never get too great because none of us is responsible for the lives of millions of people. By following the laws, we insure that both points of view are always heard and every person gets to decide for himself or herself which path to follow.
Those laws have been cast aside in the investing realm for the past 34 years. You are one of the leaders in the group of Goons insisting that the laws of this country must not be enforced re this matter. That’s why you are scared to death today.
I didn’t do that to you. Shiller didn’t do that to you. The peer-reviewed research didn’t do that to you.
You did that to you. You let your fear cause you to get on a very dark path indeed. So your fears get worse and worse and worse and worse.
The worst thing that can happen to me is that my investing plan might not work as I hoped. That’s within the realm of possibility. Is that really such a big deal.
The worst that can happen to you is that you end up in a prison cell for the rest of your life. That is huge. That is really, really, really bad.
Does the difference between what I have done to myself over the past 13 years and what you have done to yourself over the past 13 years point to a belief that investor emotions matter or not? You know what I think.
If investor emotion didn’t matter, you wouldn’t be headed to life in a prison cell, Laugh.
And all the evidence available to us shows that you are.
You are the one who is scared.
I have the normal fears that anyone has and that cannot be avoided. You have EXTREME fears because you cannot face the normal fears that we all experience when dealing with a subject re which our entire society possesses only a primitive level of understanding.
Most people are in a middle ground. Most are not going to prison. So most as not as scared as you. But most have not stood up to you Goons, so most are more scared than I am.
The thing that I won by standing up to you is that I do not have to be scared about anything other than my personal investing plan. I am right with my friends. I am right with my neighbors. I am right with my co-workers. I am right with my fellow community members. I am right with my country.
I am LESS scared than I would be if I had given in to your pressure to commit financial fraud. Yes, of course it is possible that stocks might begin behaving in a way in which they never before in history have behaved and in that event I will suffer some financial losses. That is unavoidable. We all run that risk and there is not a thing that anyone else can do about it.
You took on an additional risk when you committed financial fraud. You are 100 times more scared than me. And the only thing that can change that is coming clean. And of course you are sacred to come clean. Because you not only want to see your prison sentence shortened, you want to avoid prison altogether. And you cannot imagine any way of pulling it off at this point.
Nor can I, old friend.
I am scared FOR YOU.
I am scared re the vast amount of human misery that you have caused and re the damage that will be done to the country that I love as a result.
But I can sleep at night knowing that I have done everything in my power to get you placed in a prison sell as soon as is humanly possible.
You have resisted those efforts. That is the real source of the overpowering fears that you feel today about your own future and about the future of this country.
You have my best and warmest wishes, Laugh. It gets better. A LOT better.
I am sure.
Rob
“I would LOVE to have some research available to me showing that Buy-and-Hold might work for one or two long-term investors.”
That would be everyone who held the S&P 500 index since you sold out in 1996. The index has more than tripled, not including dividends. I haven’t counted those people, but I expect the number exceeds two.
Cue your retort “just wait till the 65% crash”, which you just admitted may well be wrong, but “what of it”?
If you don’t adjust for valuations, you can’t get the numbers right, X.
If you adjust, VII is far ahead.
I of course acknowledge that this might be the first time in history that Buy-and-Hold works for one or two long-term investors. But I cannot say that that is so until it happens.
We have not yet seen the long-term result of the failure of Buy-and-Holders of the current day to adjust their stock allocations in response to the big valuations shift of the late 1990s. That story is still playing out.
I cannot change that. I am going by the peer-reviewed research. You have elected to do otherwise. We will trade notes following the next price crash.
My bet is that even YOU and your fellow Goons will abandon Buy-and-Hold following the next crash.
But we are going to have to wait and see to know for sure, no? There is no peer-reviewed research available to us today showing us what happens in the future.
Do you see?
Rob
Yes, if we just continually reduce the actual tradeable value of stocks below that of bonds then vii looks pretty awesome. Too bad it is a fantasy.
34 years of peer-reviewed research based on 140 years of historical return data is not a fantasy, Laugh. This is real. This is the future. This is very exciting stuff.
That’s my sincere take, in any event.
I wish you all good things.
Rob