I’ve posted Entry #424 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called An Examination of Bogle’s Semi-Endorsement of Valuation-Informed Indexing.
Juicy Excerpt: It makes me crazy happy that Bogle used the word “strategic” rather than “tactical” to describe investor decisions to increase or lower their stock allocation in response to shifts in valuation levels. I am not aware of any other case in which an expert in the field referred to that sort of decision as a strategic decision; it is always described as tactical. That’s a pet peeve of mine. The purpose of changing one’s stock allocation in response to big valuation shifts should be strategic. The idea is to keep one’s risk profile roughly constant over time in a world in which valuations affect long-term returns and in which risk is thus a variable rather than a constant.
Rob,
I am now sitting on about $5 million. When can I expect that pile to turn into cotton candy nothingness?
If Shiller is right, a portion of it will be turning into cotton-candy nothingness within the next year or two or three.
There are calculators at the site if you need help with the calculations. I doubt that you need too much help. The fair-value CAPE number is 16. Today’s CAPE is 29. If you are okay with using rough numbers, you need to divide the amount that you have invested in stocks in half. One half of the full amount you have invested in stocks is real. One half is the product of economic realities. The other half is the product of irrational exuberance. It is rooted in nothing more than fleeting investor emotions.
Do you see how that way of looking at things is different from how the Buy-and-Holders tell us to look at things?
You of course know all this as the result of prior conversations that we have had. So why do you ask this question?
If you don’t agree, you don’t agree. You are obviously in good company if you do not agree. There are millions of good and smart people who are Buy-and-Holders today.
My question to you is — Do you have a problem with me or anyone else who believes in Valuation-Informed Indexing rather than Buy-and-Hold? I sincerely believe that the last 38 years of peer-reviewed research in this field is legitimate research. Do you think that I should pretend to believe otherwise to appease the Buy-and-Holders who get upset to hear that there are two schools of academic thought as to how stock investing works, not one? I do not believe that I should do that. I believe that I should post my sincere views, as should you and everyone else.
Yes?
Rob
“The fair-value CAPE number is 16”
The idea that there is a single “fair-value CAPE number” in all circumstances is nonsense.
There is no reason to believe that a single price for the stock market is correct no matter what the economic conditions or interest rate environment.
Well, you told us that this would have happened back in 2010 and then each year it was pushed out another year or two. What is different now in that you say it will be in one or two years?
I don’t agree with you, Evidence.
When people buy stocks, they are not buying them only to obtain the income stream available at the time they are making the purchase. They are also buying them for income streams that they will obtain in the future. If you buy at a time when the economy is doing well, you are also going to own the stocks when the economy is not doing well. The rational investor isn’t concerned with how the economy is doing at the moment in time when he makes the purchase. He is interested in both the current day and the future.
The CAPE value of 16 is the long-term CAPE value. If you want to know the long-term value of the asset you have purchased, that’s the best number that you can go with. When the CAPE is at two times the average CAPE, you are paying for a lot of irrational exuberance, which does not offer you any lasting value.
Rob
Well, you told us that this would have happened back in 2010 and then each year it was pushed out another year or two. What is different now in that you say it will be in one or two years?
We have never before in the history of the U.. market seen a time when stock prices have remained this high this long.
All predictions that I have offered were based on what has always happened in the past. When we see things that we have never seen before, those sorts of predictions obviously do not pan out.
What matters is whether the stock price is determined by economic realities or by investor emotion. If you believe that stock prices are determined by economic realities, then you should follow a Buy-and-Hold strategy. That follows. If you believe that stock prices are determined by investor emotion, then you should follow a Valuation-Informed Indexing strategy. That also follows.
If I had asked you in 2000 what the annualized real return would be on stocks for the next 19 years, there is no way that you would have said “2.4 percent.” A Buy-and-Holder would expect the long-term return to be something in the neighborhood of the average long-term return of 6.5 percent. But stocks were insanely overpriced in 2000. The return has been much lower than the average return for a long, long time.
So stocks have been performing consistently with Shiller’s research findings even in recent years. We just haven’t seen the return to fair-value CAPE values just yet. To know when that price crash is going to come, I would need to know when investor emotion is going to turn. It’s very hard to know when they is going to happen because it is not a rational process. What I know (or what I at least think I know) is that it is certainly going to happen sooner or later; stocks have never remained at insanely inflated prices indefinitely. Does it really matter so much precisely when it happens so long as it is going to happen sooner or later?
Shiller showed that stock investing risk is not constant but variable. Risk is off the charts at today’s prices. So investors who want to maintain a constant risk profile over time MUST adjust their stock allocations to reflect the added risk. It’s irrational not to do so.
Rob
“The CAPE value of 16 is the long-term CAPE value. ”
You tell us repeatedly that the SWR is not always the same number but you seem to think that the fair value CAPE number is always the same.
Yes. That’s very good. I like that comment a lot.
The Buy-and-Holders and the Valuation-Informed Indexers have different ideas as to what is stable and as to what changes.
Buy-and-Holders and Valuation-Informed Indexers agree that the average long-term return is 6.5 percent real. There’s no dispute re that one.
The Buy-and-Holders believe that risk is constant. This is why they believe that stocks are always worth buying. Stocks are generally an amazing asset class. If stocks are generally an amazing asset class and if risk is stable, then you should always go with a high stock allocation. The logic follows. And that of course if why Buy-and-Holders believe that the safe withdrawal rate is always the same number. The safe withdrawal rate is a risk-assessment tool. If risk is stable, the safe withdrawal rate is indeed always the same number.
Valuation-Informed Indexers believe that risk VARIES. So we of course believe that the safe withdrawal rate varies.
Identifying the fair-value CAPE number is just a math exercise. 16 is the median of all the CAPE values we have seen. Sometimes it goes higher and sometimes it goes lower. It always ends up at 16.
You are suggesting that there might be some economic circumstances in which the CAPE value would change. If our economic system became more productive, the fair-value CAPE value would be higher. That’s certainly fair to say. There’s no law that says that it will always be 16.
But of course there is no way to know in advance whether any portion of today’s scary CAPE value is attributable to increased productivity. It is possible that that is so. I certainly don’t have any problem with someone saying: “I think productivity has increased, so I am going to use a fair-value CAPE value of 18. That’s up to the investor. That’s fine.
But please note that that is subjective. Some investors may think that productivity has increased ans some may think that it has declined. They are all entitled to their opinions. But no one can state definitively that they are right on that question. “16” is my effort at identifying a neutral number. It is the average CAPE in the historical record. I don’t object if someone uses 18 or 14.
I have a problem when someone says that there is no need to make a CAPE adjustment when determining the value of their portfolio. Stock prices increased 126 percent from 1996 through 1999. Huh? What the f? Is there any reasonable person who thinks that all of those gains were the product of economic growth? I sure don’t. I think that the vast majority were the product of a runaway irrational exuberance.
That affects the determination of the safe withdrawal rate. If you believe that that 126 percent price increase was the product of economic growth, then you believe that the safe withdrawal rate in 2000 was 4 percent. If you believe that most of that 126 percent price increase was the product of irrational exuberance, then you believe that the safe withdrawal rate in 2000 was 1.6 percent.
Again, there are two schools of thought. One school believes that the market is efficient and thus risk is constant and there is no need for investors to practice price discipline (long-term timing). The other believes that valuations affect long-term returns and that risk is thus variable and it is essential for investors to practice price discipline (long-term timing) if they are to have any hope whatsoever of keeping their risk profile roughly constant over time.
Ironically, it is the promotion of Buy-and-Hold strategies that causes prices to get so out of whack as to make Buy-and-Hold dangerous. If investors were encouraged to practice price discipline, prices would never stray so far from the fair-value CAPE value and investors would rarely need to change their stock allocations. It is a widespread belief that Buy-and-Hold can work that makes Buy-and-Hold dangerous. Telling investors that it is okay not to exercise price discipline is like ripping the brakes out of a fast-moving car. Valuation-Informed Indexing puts the brakes back in and makes for a much more enjoyable long-term ride.
Rob
“Identifying the fair-value CAPE number is just a math exercise. 16 is the median of all the CAPE values we have seen. Sometimes it goes higher and sometimes it goes lower. It always ends up at 16.”
When? It briefly touched that level in 2009. Other than that, the market has been “unfair” for nearly 30 years now. Anyone who wasted that much time waiting for CAPE 16 would have to be an idiot.
More specifically, a broke idiot, with a failed retirement.
“We have never before in the history of the U.. market seen a time when stock prices have remained this high this long.
All predictions that I have offered were based on what has always happened in the past. When we see things that we have never seen before, those sorts of predictions obviously do not pan out.”
In short, you were, and are still wrong.
The idea isn’t to “wait” for anything, Anonymous. Buy-and-Holders make that mistake over and over and over and over again.
The idea is to adjust your stock allocation so that your risk profile remains roughly constant over time. Doing that has ALWAYS worked. There is not one exception in the historical record, going back as far as we have good records of stock prices.
Every investor alive on the planet would know that today if the Bennett/Pfua research paper had been featured on the front page of the New York Times when it was published in a peer-reviewed journal, as it should have been. There’s a reason why Wade said that he thought that the paper was so important that he was going to try to get it published in the lead journal in the field.
It is because you saw how important our research paper was that you threatened to send defamatory e-mails to Wade’s employer in an effort to get him fired from his job if he continued to do honest work in this field. You obviously would not have done that if you did not appreciate the great power of our research to convince millions of people to abandon Buy-and-Hold and become Valuation-Informed Indexers.
It will be interesting to see how things play out in the days following the next price crash.
I wish you all good things.
Broke Idiot Rob
In short, you were, and are still wrong.
I was wrong about when the crash would arrive.
All of the evidence available to us today indicates that I was right that stock prices are determined primarily by shifts in investor emotion and only secondarily by economic developments. That’s the one that matters.
I was OBVIOUSLY right in saying that the retirement study posted to John Greaney’s web site lacks a valuation adjustment. He and all of you Goons should have acknowledged that one on the afternoon of May 13, 2002.
Sometimes Wrong Rob
“The idea isn’t to “wait” for anything, Anonymous.”
Aren’t you the one that always says that we should wait to see how everything turns out?
No one practicing Valuation-Informed Indexing ever needs to wait for anything. That’s the point. You just do what you need to do at all times to keep your risk profile roughly constant and you will end up fine in the long run.
When I talk about how we need to wait to see how things play out in the days following the crash, I am not talking about anything required by the VII strategy. We need to wait because you Goons are so abusive that Normals are afraid to stand up to you and insist that honest posting on the peer-reviewed research be permitted. They will be more motivated following the crash because they will have suffered losses. I believe that at that time we will get a few sites opened up and then, once those gain popularity, the thing will just go viral.
Or so Rob Bennett believes, you know?
Rob
“The idea isn’t to “wait” for anything, Anonymous”
You talk about nothing but stocks, but you’ve owned no stocks since 1996. If that’s not waiting, what is it?
It’s following a research-based strategy for investing in my favorite asset class.
It’s not my fault that stock prices have remained at insanely high prices for a longer time than ever before in history. I have been saying that we should permit honest posting. If we permitted honest posting, millions of investors would see the benefits they could gain by lowering their stock allocations and those sales would bring prices down to reasonable levels, where stocks offer an outstanding long-term value proposition.
It’s the Ban on Honest Posting that is causing all the trouble.
Rob
“It’s following a research-based strategy for investing in my favorite asset class.”
Your favorite asset class, which you haven’t owned in 23 years. Did that tidbit of information make its way into the article that you’ve been scattering far and wide? Or was there just no way to squeeze it into that tight 11,000 words?
I don’t mention that in the article. It’s not my intent to hide it. If I were hiding it, you wouldn’t know about it. But you are right in your suggestion (which you advance in a sarcastic tone) that it was hard to find room for all of the essentials of this story in a single article. There were other things that had to be said, so that got left out. My #1 project for 2019 is to take that article (which I am extremely pleased with — I view it as the finest piece of journalism that I have ever produced) and to blow it up to full-book length. I will certainly be discussing the fact that I got out of stocks in the Summer of 1996 in the book. So people who are hearing my case in the place in which I put the entire story forward in one telling will know that.
You want them to know because you know that most people will find it offputting. People’s minds have been saturated with Buy-and-Hold thinking. So most people think that the idea that TIPS or IBonds could do better than stocks for 23 years running is absurd. The reality is that that is what has happened. If there had been no Ban on Honest Posting, if we had been talking about these issues at every discussion board and blog for the past 17 years, all investors would understand why they should expect TIPS and IBonds to beat stocks when as a society we permit stock prices to reach the levels that we have permitted them to reach during the Buy-and-Hold Era.
Here is the annualized real return, with dividends reinvested, for stocks starting from the various, relevant starting points:
January 1996 — 5.7 percent
January 1997 — 5 percent
January 1998 — 4 percent
January 1999 — 2.9 percent
January 2000 — 2.4 percent
I was getting big raises in those years. So I was able to save a lot more in the later years than in the earlier years. So it is the numbers for the later years that are most relevant. My 3.5 percent return beats the number for stocks in 2000 and in 1999. It comes close in 1998. It gets beat in 1997 and 1996. But if you adjust for risk (I think it would be fair to say that an investor should be compensated two additional points of return for taking on the much greater risks associated with stocks), the TIPS/Ibonds number wins in 1997 and gets beat by only a little in 1996.
Factor in the effect of a 50 percent price crash, and the TIPS/Ibond numbers are ahead across the board. Then consider that stocks will probably be offering a 10-year annualized return of 15 percent real after the crash, and that differential grows a lot bigger after the Valuation-Informed Indexer is able to take advantage of the fact that, by lessening his participation in the stock market when it offers a poor value proposition, he is able to increase his participation in it when it is offering a strong value proposition.
The Valuation-Informed Indexer comes out ahead in the long run. I have run many hundreds of scenarios on the Scenario Surfer. There are lots of variations re the details of the various return sequences. But the bottom-line reality is always the same. Practicing price discipline when buying stocks pays off big time in the long run. Surprise! Surprise! Who’d a thunk it?
Stocks have performed HORRIBLY for the past 19 years. You should be ashamed of that 2.4 percent number. Millions of people depend on the magic of compounding to finance their retirements. The magic is reduced considerably when the annualized return is reduced from the normal 6.5 percent real to a shocking 2.4 percent real. That number is killing us as a nation. We are all hurting because of that number.
What caused that number? It was that insane 126 percent price jump that we saw from 1996 through 1999. We are still paying for that. And what caused those four years of insanity? Buy-and-Hold. People thought those phony gains were real. So they didn’t bother to exercise price discipline. And we are all still paying the price for that horrible mistake 19 years later.
Yes, people are shocked to hear that I have been out of stocks for nearly 23 years. Most people have never heard the case against Buy-and-Hold. What people should be shocked about is that I have been out of stocks for nearly 23 years and I am ahead today because of my decision to go with the peer-reviewed research instead of the marketing slogans of our Wall Street Con Man friends. And I will be farther ahead following the next price crash, which will bring more devastation to millions of middle-class people. Again, courtesy of everybody’s favorite Get Rich Quick scheme.
We should all be striving to invest rationally. Our common sense tells us that price discipline must work when buying stocks because it works in every other market that has ever existed. We now have 38 years of peer-reviewed research confirming that what our common sense tells us must be so really is so.
We have as a society spent millions of dollars promoting the purest and most dangerous Get Rich Quick scheme ever concocted by the human mind. I think it would be a good idea to now spend an equal amount of money promoting the first true research-based approach, the first strategy developed after the research needed to get it right was available to us all.
Valuation-Informed Indexing is what Buy-and-Hold was intended to be. We should fix the mistake and move forward as a people. There is no good reason to deny ourselves the benefits of Shiller’s Nobel-prize-winning research any longer. Knowing how to invest effectively for the long run is a good thing. Learning how to pronounce the words “I” and “Was” and “Wrong” gets us to the place that deep in our hearts we all really want to go. Those three words have an incredible liberating power.
Stocks are my favorite asset class. And yet I have been out of stocks for close to 23 years now. Huh? What the f? It says something about us as a people that a person who believes that the lessons of the past 38 years of peer-reviewed research should be acknowledged has had to stay out of stocks for 23 years as a result. That’s freakin’ crazy. But it is not the investor who follows the research who is off his meds, as you Goons like to suggest. It is the people still advocating Buy-and-Hold strategies 38 years after the peer-reviewed research in this field showed that there is precisely zero chance that such strategies could ever work out well in the long run who are off their meds.
No society as rich as ours should ever have to endure an annualized stock return of 2.4 percent real for 19 years running. That number is a summation of the horrors of what the widespread promotion of Buy-and-Hold has done to us as a people. It’s a national scandal. That never could have happened in a world in which we permitted honest posting re the peer-reviewed research.
I should be able to invest in stocks and earn a return at least somewhat approaching 6.5 percent real doing so. We all should. Once we open every discussion board and blog on the internet to honest posting re the last 38 years of peer-reviewed research in this field, we all will be able to do so from that point forward. It is Buy-and-Hold holding us back and Buy-and-Hold can be corrected by a society of people with enough concern for its future to enforce the laws against financial fraud.
My sincere take
Beating-2.4-Percent-Real-for-19-Years-Running Rob
“My #1 project for 2019 is to take that article … and to blow it up to full-book length.”
Yeah right. You’ve been talking about writing a book for over a decade. Tell you what, if that book ever makes it to Amazon, I’ll buy a copy. Which would be your first earned income in 20 years.
The rest of your comment is the same old combination of lies and transparently flawed logic that you’ve been spewing forever. It’s too tiring to rehash it all again. But that’s what you count on, isn’t it? Get your points shredded, let it sit for awhile, then post the exact same nonsense again, as if the shredding never happened.
I wrote a first draft of the book (“Investing for Humans: How to Get What Works on Paper to Work in Real Life”) a good number of years back. I learn more every day. I did not possess a clear enough understanding of all the issues back then to present the entire story in a sufficiently clear and organized way to satisfy my standards for a book (blog posts and columns are much easier to write because they cover so much less ground and thus the organization part of the job is much easier to pull off). When I finished the “Buy-and-Hold Is Dangerous” article and saw how much better it came out than my earlier attempt to write the book, I realized that it was time to take a second stab at getting the words for the book down on paper. So that is my current project. My goal is to finish it by the end of this year.
My hope is to be able to finish the book before prices crash. I believe that the crash will open some people’s minds to consideration of the last 38 years of peer-reviewed research. We already have about 10 percent of the population on board. I believe that another price crash might get us to 20 percent and that that may be enough for us to overcome the abusiveness of you Goons. And. once you Goons are out of the picture, it is just good stuff piled on top of good stuff piled on top of good stuff for the people of the United States. I sure hope so, in any event.
I wish you the best of luck in all your future endeavors, my dear Goon friend.