I’ve posted Entry #510 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Why Does It Take So Long for Stock Prices to Correct?
Juicy Excerpt: I believe that the Valuation-Informed Indexing Model offers a better description of what is going on, though certainly a less logical one. Stock price changes are determined not by economic developments but by shifts in investor emotion. The investor emotion that has been keeping stock prices up for 24 years now will eventually fade and prices will come down to earth. But that will not happen when it should happen, which was back in 1996 when Shiller wrote about the possibility in his paper. It will happen when investors give up their fight to block it from happening, which obviously is going to turn out to be a lot later than Shiller and I imagined possible.
24 years out of the market is a disaster. Look at bond rates. Inflation eats you alive. Markets have ALWAYS recovered from any drops.
I agree that it is generally a mistake to get entirely out of the market at any time (except in unusual circumstances, like my own).But I strongly believe that investors should adjust their stock allocation when prices reach the insane levels where they have resided for most of the past 24 years. Shiller showed that stocks are riskier when prices are high. An investor who fails to engage in market timing when prices reach crazy levels is permitting his risk profile to go wildly out of whack. Huh?
The market is certainly going to recover from the drop eventually. But an investor who fails to keep his risk profile constant pays a very big price for his unwillingness to do so. If the CAPE value were to fall to 8, as it has at the end of all earlier bull/bear cycles, stock investors will see their portfolio value diminish by 70 percent. Then they will lose the compounded returns that they would have earned on that money for the remainder of their investing lives. The peer-reviewed research that I co-authored with Wade Pfau shows that Valuation-Informed Indexers are able to retire much earlier while taking on only a fraction of the risk taken on by Buy-and-Holders. That sounds good to me.
Buy-and-Hold is a marketing gimmick. If there were any peer-reviewed research showing either that market timing (price discipline!) might at some point stop working or stop being required, you would have advanced it a long, long time ago. Get Rich Quick strategies help the people who sell stocks in the short term but they hurt investors very seriously in the long term. Not this boy.
Rob