Set forth below is the text of a comment that I recently put to the discussion thread for another blog entry at this site:
And you want us to wait, even if it takes 73 to 86 years more for it to play out, right?
I’ve asked myself that question, how long would I wait? Shiller predicted in 1996 that those going with high stock allocations would regret it within 10 years. That would have been 2006. We are now 12 years past that. This is the longest that we have ever gone with stocks at crazy high prices and not seen them crash (they crashed in 2008 but prices went back up after the passage of only a few months, so that crash didn’t turn out to be terribly consequential). Does there come a point when you just say “this has continued for so long that it just doesn’t make sense to continue to expect a crash?”
The long wait is a point against Valuation-Informed Indexing, in my assessment. I can see someone saying “if stock prices had just recently risen to crazy high prices, I would listen to Shiller and Bennett and lower my stock allocation but this has gone on so long that I feel that they are like the boys who cried wolf, I just do not have confidence that what they are saying will happen will actually take place.”I don’t agree with that view. But I don’t see that view as being entirely unreasonable. So I don’t say that someone who concludes that “it has taken too long for prices to crash” and therefore rejects Valuation-Informed Indexing is crazy.
The problem that I have with that view is that we all need to invest our money. If you are considering making a bet on the World Series but you can’t figure out whether the Red Sox or the Dodgers are the better baseball team, you can just elect not to place a bet either way. You can opt out of the choice. You can’t do that as an investor. You can’t say “Valuation-Informed Indexing beats Buy-and-Hold for about 10 different reasons but I am concerned about how long it has taken for the crash to arrive so I am just going to opt out of making a decision re how to invest my money because I don’t want to get it wrong.” You’ve got the money, so you have got to make a choice. There is no opt out.
I think the case is so strong for Valuation-Informed Indexing and so weak for Buy-and-Hold that I could not bear to elect to go with Buy-and-Hold. So I still go with Valuation-Informed Indexing even though it has taken a long time for the crash to come. What if it took another 100 years for the crash to come? Would I still opt for Valuation-Informed Indexing in those circumstances?
I don’t see how I could opt for Valuation-Informed Indexing in those circumstances. That would just be too crazy.
But where do you draw the line? At what point do you say “it has taken too long for the crash to come” and abandon the concept? I cannot answer that question. If there were a great alternative, if would make sense to move to it. But there’s not. If some brilliant researcher came up with a third model that seemed to make sense, I would be inclined to investigate that third model and see if it might be a better answer than the two existing models. But there are no signs of that happening. I could see eventually moving in the direction of a middle ground, changing my stock allocation in response to what the last 37 years of peer-reviewed research shows but not changing it as much as that research suggests because of a concern that the crash hasn’t arrived in the time that you would expect it to arrive based on what has happened through history. That will probably be my path if the crash does not come for a long time.
But I cannot see going with Buy-and-Hold. It just doesn’t stand up to scrutiny. Price discipline is key in every market that exists and the Buy-and-Holders have never given any reason for their belief that it isn’t needed in the stock market. Wade Pfau spent months searching the literature for studies showing that it is not necessary to practice long-term timing when buying stocks and he came up empty-handed. So I just do not feel comfortable going there. It seems at least possible to me that there might be some way to practice price discipline (long-term timing) other than what the peer-reviewed research available to us today teaches us. I don’t think that we know all the answers. But I cannot see going backwards. Buy-and-Hold has failed. Shiller checked whether its premise (that the market is efficient, that prices fall in the pattern of a random walk both in the short term and in the long term) held up to scientific scrutiny and Buy-and-Hold failed the test. I cannot see going back to it unless the Buy-and-Holders offer some explanation for why their model failed the test that it must pass for the model to be valid.
I believe that the case for Valuation-Informed Indexing is 100 percent rock-solid GOING BY THE EVIDENCE AVAILABLE TO US TODAY. Not all of the evidence is available to us today. You are raising a hypothetical where we see another 73 years pass without a price crash. I agree that that would change things. But I cannot say precisely how many years it would take for me to change my views. 73 years would certainly bring a change (but probably not to Buy-and-Hold, I would need to look for some third option), five years would certainly not bring a change, given how strong the case is for Valuation-Informed Indexing today. Somewhere in the middle of those two scenarios, I would experience enough doubts that I would begin to shift away from Valuation-Informed Indexing and perhaps somewhat in the direction of Buy-and-Hold.
The question you are asking is a good one. Skepticism is part of the scientific process. If people are not skeptical toward Valuation-Informed Indexing, we will not learn of its flaws and that would be a negative for all of us. So the skepticism is good. I wish that you would direct some of that skepticism toward Buy-and-Hold. In addition to asking how many more years Valuation-Informed Indexing advocates can go without seeing a crash, you should be asking how many more years of price-return data Buy-and-Holders need to see in which valuations affect long-term returns before they are willing to acknowledge that the market is not efficient and that price increases that take stock prices beyond fair-value levels do not represent economic realities but only the effect of an irrational exuberance on the part of stock investors.
You are with this question pointing to the weak spot in the case for Valuation-Informed Indexing. I think that the overall case is very, very strong. But, when I am going over the case in my head to determine whether I might have gotten something wrong, this is the question that my mind turns to. I have explanations for why it has taken so long for prices to crash. Valuation-Informed Indexers need to try to answer that question if they are to retain their intellectual integrity. It is not a question that can be ducked. So I have explanations that are partly satisfying in my mind. However, I am not sure that I can say that all of them added together are completely satisfying. This aspect of the question troubles me a bit. If there were completely satisfying models available, I would be at least checking them out at this point in the proceedings.
So thanks for asking the question.
Somewhat Questioning But Generally Steadfast Rob
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