“The Dispute Is Over Whether Those Big Price Drops Can Be Effectively Predicted and Over Whether Those Big Price Drops, Which Do Great Harm to Millions of Investors and Indeed to Our Entire Economic System, Can Be Avoided. Whether They Can Be Predicted and Avoided Depends on Whether Stock Price Changes Are Caused By Economic Developments or By Shifts in Investor Emotion.”

Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:

Dear Mr. Bennett,

Based on the stock crash today, it seems you must be correct. We are ready to put your story on the front page of our paper. Please stop by our offices so that we can get started. We will also arrange for Brinks to have a truck on standby as you begin to collect your $500 million in settlement payments.

When this comment was posted last Monday, I deleted it because it is so obviously lacking in good intent. I have reconsidered and approved the post and am writing this response because I believe that there is a point being made implicitly in the comment that should be addressed.

The comment was advanced on a day when there was a drop in stock prices. The idea here is to make a sarcastic observation on the price drop suggesting that all that Valuation-Informed Indexing is about is a belief that stock prices sometimes drop dramatically and that, if Buy-and-Holders accept that as a reality (they do), then there is really no big problem with the 17-year (or 38-year, if you date it back to 1981) cover-up. There is a big problem.

I of course accept that Buy-and-Holders acknowledge that stock prices at times fall hard. All Buy-and-Holders get that. The dispute is over whether those big price drops can be effectively predicted and over whether those big price drops, which do great harm to millions of investors and indeed to our entire economic system, can be avoided. Whether they can be predicted and avoided depends on whether stock price changes are caused by economic developments or by shifts in investor emotion. If price changes are caused by economic developments, prices should fall in the pattern of a random walk and they can be neither predicted nor avoided. If price changes are caused by shifts in investor emotion, long-term CAPE values should fall in a repeating hill-and-valley pattern (they have done so since 1870, which is as far back as we have good records of stock prices) and they can be both predicted and avoided (if we tell investors when high prices make stocks a poor value proposition, people will lower their stock allocation when prices reach crazy high levels and the sales will pull prices back to reasonable levels).

The sort of price change that we saw last week is no big deal and Buy-and-Holders are fighting a straw man when they show that that particular price drop was a matter of little significance. What the Valuation-Informed Indexers and the last 38 years of peer-reviewed research say is that stocks were a dangerous asset class both before last week’s price drop and after it (because the CAPE value was insanely high at both times). Investors should always practice price discipline. Stocks can come back from a price drop of the type that we saw last Monday. But the fact that stocks are far more dangerous an asset class when they are at today’s prices than they would be if prices were at normal levels remains an important reality. It doesn’t matter too much when the price drop will come. The thing that matters is that it WILL come if stocks continue to perform in the future anything at all as they always have in the past. Investors need to know that and to adjust their stock allocation in response to that critically important investment reality.

I hope that helps a tiny bit, New York Times.

Brinks-Truck-Awaiting Rob