I’ve posted Entry #469 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Shiller’s Breakthrough Was Not to Show Us How Stock Investing Works, It Was to Show Us How to Change How It Works.
Juicy Excerpt: Shiller did indeed describe how stock investing works. But his primary accomplishment reaches far beyond the descriptive. He showed us how to make stock investing a less risky and more profitable investing choice. His research does not just describe what is going on in the market. It gives us all the tools we need to change what is going on in a very big and very positive way. Three cheers for market timing!
Rob, do you have a sense, based on your decades of expertise in this area, of where stock prices will be in 3-4 years? Or what fair value today? For example the S&P 500 is about 3,200 today. Where should it be?
This is a good question.
I don’t like it when you say that I have “decades of expertise in this area.” I have been exploring the Valuation-Informed Indexing concept on a full-time basis since the morning of May 13, 2002. That’s 17-plus years. So it would make sense to say that I have nearly two decades of effort developing my expertise (and of course there was a good bit of research in the preceding years that led me to putting forward the May 13, 2002, post). But the phrase “decades of expertise” suggests something more than that. Why word it that way? Why not just state things as they are? If you were trying to learn, you would always do your best to state things as they are, not to engage in exaggeration or sarcasm. This is a small point here since the phrase was included in a generally helpful post. But I think it is worth nothing because it is the hostile emotions that lie behind the use of exaggeration and sarcasm that so often cause discussions to go off the rails.
The fair-value CAPE number is 16. We are today at 30. So we should be expecting a price drop of roughly 50 percent. That would be rational. Now, the full reality is that the market has always gone to insanely low CAPE values at the end of a bull/bear cycle (which can extend for 40 years). So we might be looking at a price drop of as much as 70 percent. Perhaps we should use 60 percent as the compromise number.
The usual rule is that you can only predict stock returns 10 years out (it takes 10 years for rationalism to assert itself and to cause prices set by investor emotion to correct). But in this case the price drop is long overdue (Shiller predicted in 1996 that we would see a big price drop by 2006). So it is reasonable to say that we should expect to see the price drop in a lot less than 10 years. I think it is perfectly reasonable to say that we should expect to see it within three or four years. The only caveat that I would add is that we can not be certain of that. We cannot be certain because we are talking about the effect of investor emotions and emotion shifts are hard to predict in a precise way. We must consider the effect of emotions because this is such a big factor but we are fooling ourselves if we come to believe that we can predict emotion turns with great precision (please note the Shiller prediction referred to above).
I hope that that is at least a tiny bit helpful, Anonymous.
17-Years-of-Expertise (But Not Much More Than That) Guy Rob
“So it is reasonable to say that we should expect to see the price drop in a lot less than 10 years I think it is perfectly reasonable to say that we should expect to see it within three or four years. ”
You have made the same comment over and over again. Time passed by and it never happened. Timeframe is important because as you wait, you are spending down your nest egg. If you get your timing wrong, it is a disaster.
We disagree, Anonymous.
You are saying that the timeframe matters for me because the criminal actions of you Buy-and-Hold Goons have blocked me from earning an income for over 17 years now. Those circumstances obviously do not apply for even one other person on the planet. So that just doesn’t matter in the grand scheme of things. And of course I will be receiving compensation in the lawsuits that I bring against those who covered up your criminal acts. In the event that I receive compensation of $500 million or more, I obviously end up in good financial shape.
The timeframe matters for all other Valuation-Informed Indexers in a different way, of course. That’s something that we should be researching and debating at every investing web site on the internet. I think that it would be fair to say that the best policy is not to be extreme in one’s efforts at market timing. It is a rare case where an investor would be smart to go with a zero stock allocation. My rule of thumb is that it makes sense for the typical investor to go with 60 percent stocks at times of moderate valuations, with 30 percent stocks at times of insanely high valuations, and with 90 percent stocks at times of insanely low valuations. That strategy has been dramatically reducing lifetime risk while also dramatically increasing lifetime return (compared to a strategy of sticking with a 60 percent stock allocation at all times) for as far back as we have good record of stock prices.
My best wishes to you and yours, dear Goon friend.
Disaster-Avoiding Rob
Sounds like the stock market should always be about half of where it is, and you’re the only person on the planet who knows that astounding fact. Seems just a little odd.
It’s very odd, Anonymous.
But it is not only me who says that valuations affect long-term returns. Robert Shiller was awarded a Nobel prize for showing with peer-reviewed research that this is so. Wade Pfau spent 16 months studying the matter in great depth and concluded that: “Yes, Virginia, Valuation-Informed Indexing works!” And we have had thousands of community members express a desire that honest posting be permitted. If those people don’t know the realities, they at least suspect them and appreciate that they need to explore them more to enjoy a super learning experience.
So what the heck is holding us back? It’s that darn Ban on Honest Posting. Do away with that, and we all live better lives from that point forward. The only problem here is that Fama published his research before Shiller published his. If Shiller had published his research first, we would all be Valuation-Informed Indexers today. But it didn’t happen that way. Fama was first and an entitre industry was formed around the promotion of Buy-and-Hold. And now it is very, very, very hard for all of the people who have promoted Buy-and-Hold to acknowledge their mistake.
It doesn’t get easier when the Ban is extended. It gets harder. Every day that the cover-up continues it is harder than it was the day before for our Buy-and-Hold friends to come clean. So we all have to pull together and do everything in our power to bring that darn Ban on Honest Posting to a full and complete stop.
Are you in?
Cover-Up Critic Rob
“But it is not only me who says that valuations affect long-term returns. Robert Shiller”
It’s obvious P/E valuations affect stock returns, just like interest rates affect bond returns. Sometimes demand for capital is low, valuations are high, and stocks have low expected returns. All perfectly rational. No crystal ball required.
But expecting low returns is very different from thinking stocks are going to drop by 60%. Robert Shiller would be the first to tell you that.
I don’t agree.
If you were confident that Shiller would say what you say he would say, you would drop all of the criminal stuff and invite him to speak to this subject at the Bogleheads Forum and he would do it. That has never happened. Please explain.
And, in your hypothetical, you say that stocks have low expected returns and yet valuations are high. Why would stocks be priced high when people are expecting returns to be low? That does not make sense.
In any event, if valuations affect returns, there is zero chance that the safe withdrawal rate is the same at all valuation levels. If valuations affect returns, then stock investing risk is not constant but variable. The safe withdrawal rate is a risk assessment tool. If risk is variable, then a valid risk assessment tool must produce numbers that vary.
Rob