Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:
You are very good at pointing out that the Greaney study doesn’t contain a valuation adjustment. You are much less good at explaining why it needs one.
It needs one because Shiller’s Nobel-prize-winning research shows that valuations affect long-term returns.
Price discipline is required in every market that ever existed. The only reason why anyone ever thought that it might be different in the stock market is that some economists believed in the Efficient Market Theory in the days before Shiller publushed his research. If the market were efficient, market timing would not be required and Buy-and-Hold would be the ideal strategy. But it’s not. If the market were efficient, there could never be overvaluation or undercaluation. The rational thing would be for investors to price stocks properly. The reason why they do not do that is that they are emotional humans. They like the idea of getting something for nothing. So they push prices up to unsustainable levels. That’s irrational exuberance. That’s the thing that makes stock investing risky.
The Bennett/Pfau research shows that we can reduce stock investing risk by nearly 70 percent by one simple step — encouraging all investors to practice market timing at all times. So long as all investors know to practice market timing, stock prices are self-regulating. When they get too high, informed investors sell a portion of their stocks and that pulls prices back to reasonable levels. When most investors are not practicing market timing/price discipline, prices get out of control and eventually we see a price crash and an economic crisis (because massive amounts of consumer buying power are lost in a price crash).
No market can function without price discipline. In the stock market, price discipline is achieved through market timing. So market timing is absolutely essential.
Stock market risk is not constant, it is variable. The CAPE value tells us how risky stocks are at a given point in time. The safe withdrawal rate is a risk assessment tool. It is not possible to calculate the safe withdrawal rate accurately without looking at the factors affecting risk and the valuation level is by far the most important factor affecting risk. In a world in which valuations affect long-term returns, it is a logical impossibility that anyone could calculate the safe withdrawal rate without taking into consideration the valuation level that applies on the day the retirement begins.
We have seen safe withdrawal rates as low as 1.6 percent and as high as 9.0 percent. People planning retirements need to know which it is for their particular retirement. Taking valuations into consideration makes it possible to calculate the safe withdrawal rate accurately and honestly and in a research-based way. A researcher who fails to take valuations into consideration is going to get the numbers wildly wrong. Retirement studies that get the numbers wildly wrong hurt people in very serious ways. Investment analysis should be aimed at helping people, not hurting them.
Rob
The top 10% own 90% of all assets, including stocks. The problem is that most people cannot afford to own enough stock because they haven’t save enough (just like you). If you think stocks are valued too high, don’t buy it. Don’t expect people to sell you their assets for cheap. If some guy is selling his house for $1 million, why should he sell it to someone only willing to pay $100,000 just because he thinks it is too expensive?
If you want something, be prepared to save up the money and pay what someone is asking for it. Otherwise, you are out of luck.
I completely agree that people should sell their stocks for what they think they are worth. That’s how market prices are set. Where we differ is that I say that people shoulde have access to all of the information they need to determine what their stocks are worth. There is now 41 years of peer-reviewed research showing that valuations affect long-term returns. We should be discussing the how-to implications of that research at every site. That would permit people to set the price of their stocks properly. It would permit the price to return to real-value levels from the crazy levels we have seen apply during the Buy-and-Hold Era.
The market can never be 100 percent efficient so long as we all carry a Get Rich Quick/Buy-and-Hold impulse within us. But I believe that we can bring the market much closer to efficieny than it has been in recent decades by opening every site to honest posting. People need information to form proper assessments. The last 41 years of peer-reviewed research is important information, We should be permitting discussions of it everywhere.
That’s my sincere take re this terribly important matter, in any event.
Rob