I’ve posted Entry #330 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Two Ways That Bogle Could Have Reacted to Shiller’s Research Without Admitting a Mistake.

Juicy Excerpt: It was easy to rationalize not incorporating Shiller’s findings into one’s investing strategy in 1981; stock prices were at rock-bottom prices — the thinking no doubt was that this was a “no harm/no foul” situation. The potential harm grew larger as prices rose throughout the 1990s. But then so did the embarrassment that would result from suddenly coming clean. It is a lot easier to own up to a mistake within a few weeks of when it is discovered than it is to do so several decades down the line. The price crash and economic crisis of 2008 of course made it more imperative than ever that the Buy-and-Holders come clean while also making their psychological need to avoid doing so all the more pressing at the same time.

It’s been 35 years now. Everyone who works in this field understands on some level of consciousness that the most important question before investors today is the question of how much they should adjust their stock allocations in response to valuation shifts. And yet very few address themselves to this question in a serious way. Discussing the implications of Shiller’s findings has become socially taboo. Holding open debate on these critically important matters opens too big a can of worms. Doing so might help us avoid future economic crises. But how do we explain to ourselves our failure to not take advantage of what we learned in 1981 to avoid the last one?

 

I’ve posted Entry #329 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Free Market Advocates Should Be Ashamed of Stock Crashes.

Juicy Excerpt: I am a conservative (with sympathies for a good number of liberal positions). One of the things that makes me a conservative is my love for free markets. So I naturally want to see our free market work. I don’t like stock crashes because they send a message to millions that they don’t.

And I think it is largely futile to try to convince people who have recently lived though a stock crash that free markets work. People are more influenced by personal experiences than they are by ideological arguments. When stock prices crash and people see their lives ruined, they look for something to blame. The obvious place to direct the blame for a stock crash is with the people who argue for the free markets in which stock crashes take place. Crashes undercut all of the many otherwise good arguments that conservatives make for free markets in the minds of millions of people.

I’ve posted Entry #328 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called The Jump in Stock Prices Following Trump’s Victory Could Be a Bad Sign.

Juicy Excerpt: My concern is over the question of why investors are reacting to Trump’s election in the way they are. A Buy-and-Holder would say that it is because they expect to see tax cuts or a huge bill that will produce jobs and spending and profits. But someone who believes that price changes are caused by shifts in investor emotion sees something different in this investor reaction. I see investors who are fearful that a crash is coming and who are trying to quiet those fears and who are generating optimism about the economic effects of Trump’s election as a means to do so.

Stock prices were insanely high in 1996. It would have been correct (in my view) to conclude from that that stocks were dangerous. However, it would not have been correct to conclude that stock prices would fall hard in 1997. As we saw, stock prices soared in 1997 and in 1998 too and in 1999 as well. A natural human reaction in times of desperation is to embrace the thing that is causing the fear that cannot be acknowledged. An alcoholic drinks harder to prove to himself that he has things under control. A man close to losing his job becomes more outspoken in criticism of his boss to persuade himself and those within hearing distance that he is sure that all is well.

Are we bidding up stock prices because we think that Trump is going to take the economy to a good place? Or are we fearful that the time to pay the piper for the phony profits of the past 20 years has finally arrived and feeling a need to convince ourselves otherwise with one final high-valuations fling?

I’ve posted Entry #327 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Using Historical Return Data to Guide Your Investing Strategies Leads to More Uncertainty, Not Less.

Juicy Excerpt: Silver’s take was rooted in two realities: (1) three-point polling errors are common; (2) there was an unusually high number of undecided voters going into the election and that increases the chances for seeing a polling mis-prediction. Silver did not ignore the polls; his take was that Clinton had a two in three chance of winning because the vast majority of polls favored her. But he took notice of the limitations of polls, that there are some things that polls cannot measure; for example, some voters make up their minds on the day of the election and it is thus impossible for polls taken before the day of the election to predict effectively how they will vote.

Many Trump supporters dismissed polling altogether; not knowing what the polls said permitted them the luxury of giving in to their pro-Trump bias and concluding that he was certain to win. Many Clinton supporters pointed to the pro-Clinton polls as scientific evidence but failed to consider the limitations of the science, thereby permitting themselves a certainty as to the outcome that they pretended was rooted in what the polls showed but in reality was not. It shows respect for the science of polling to note its limitations. Truly scientific explorations demand an intellectual discipline that leads to more uncertainty, not less.

I’ve posted Entry #326 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Three Return Scenarios That Applied in the Wake of the 2008 Crash.

Juicy Excerpt: It’s not just the drop in their portfolio values that cause Buy-and-Holders to panic in the wake of price crashes. Another factor is their belief that price changes are caused by unforeseen economic developments. If one believes that price changes are caused by economic developments and prices fall hard, the obvious conclusion is that the economy is in bad shape. It is more than a little troubling for investors whose retirements depend on the smooth operation of the economy to learn suddenly that it is not doing at all well. Buy-and-Holders are hit with a double dose of bad news when stock prices crash.

The Valuation-Informed Indexing strategy helps investors develop a more balanced mindset. It is of course a negative that crashes cause portfolio values to diminish. But the other side of the story is that every drop in valuations causes long-term return expectations to increase. So the investor who is investing for the long term and who follows a Valuation-Informed Indexing strategy does not view a price crash as a negative; he sees it as a negative countered by a positive, an event that has an overall neutral effect on his retirement prospects. No one panics in response to neutral events.

I’ve posted Entry #324 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Valuation-Informed Indexers Only Temporarily Miss Out on Gains When Bull Markets Continue Longer Than Expected.

Juicy Excerpt: Valuation-Informed Indexing strategies often do not pay off for a good bit of time. That much is certainly true. But they always pay off (at least on a risk-adjusted basis and usually even on a nominal basis) to those patient enough to permit the various waves of investor emotion to play out. Stocks were not worth buying at the prices at which they were being sold in 1996. The insanity of the last four years of the century did not render the smart choice to protect one’s portfolio by lowering one’s stock allocation a less-than-smart one. The power of that second wave of investor emotion delayed the day of reckoning for Buy-and-Hold investors while increasing the price they paid.

There is no getting around the price that follows from following Buy-and-Hold strategies. But the price can arrive in several different forms. There are always a variety of wave scenarios that may apply in given circumstances. Investors need to consider the possibilities, note how they apply to those in their particular circumstances, make the choices that follow from those considerations, and then exercise the patience needed for the various wave scenarios to play out.

It can be frustrating and unsettling waiting for the various wave scenarios to play out. But Valuation-Informed Indexing strategies always work if given enough time. The reason why is that they MUST always work. Long-term timing is how price discipline is exercised in the stock market. It is absurd to think that there might be a market in which it were a good thing to fail to exercise price discipline. Price discipline is a positive, valuations always matter and Valuation-Informed Indexing is always superior to Buy-and-Hold in the long term.

I’ve posted Entry #323 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called It Is Not Reasonable to Expect a Perfect Correlation Between Valuations and Long-Term Returns.

Juicy Excerpt: There is never one wave of emotion passing through investors at a point in time. There are always multiple waves, some pushing prices up and some pushing prices down. The price that applies is the product of the interaction of the various waves of emotion. The P/E10 level from an earlier time can inform us as to the probabilities of each of the various waves of emotion being dominant at a point in time but they can never specify with certainty which wave will be dominant or to what extent it will be dominant. Hence,the correlation between the P/E10 level that applies at the time a prediction is attempted and the return that ends up applying in reality can never be perfect.

Stock returns are as predictable as we should expect them to be if Shiller is right that it is investor emotion that plays the dominant role in setting stock prices. We need to learn how to think about stock investing in the new world ushered in by Shiller’s 1981 research. Once we become comfortable with a new way of thinking, I believe that we will come to worry less about the statistical tools showing how strong the correlation is and focus more on how big an advance it is for us to be able to predict long-term returns to the extent that is now for the first time in investing history possible.

I’ve posted Entry #322 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called The Money That Disappears in a Stock Crash Never Existed in Any Real Sense in the First Place.

Juicy Excerpt: The problem, of course is the Buy-and-Holders. Their reputations are riding on their ability to persuade those of us who appreciate the far-reaching implications of Shiller’s findings to keep it zipped and to persuade millions of investors that they knew all there is to know about how stock investing works long before Shiller arrived on the scene. Grrrr.

I’ve posted Entry #321 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Valuation-Informed Indexing Combines the Best Elements of Fundamental Analysis and Technical Analysis.

Juicy Excerpt: Shiller is not a technical analyst but he has incorporated one very valuable element of technical analysis into a framework dominated by fundamental analysis considerations and he thereby has developed something new, a balanced model that I believe in time will bring the long ongoing conflict between fundamental analysts and technical analysts to an end by allowing each of the warring camps to come to a better appreciation of the merits of the other fellow’s perspective. Stock returns really are predictable. But only in a limited sort of way. The fundamental analysts have been too complacent in their belief that the things they know are all there is to know and the technical analysts have reached too far too quickly and discredited their genuine contributions by doing so.

I’ve posted Entry #320 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Effective Financial Planning Becomes Impossible During Both Bull and Bear Markets.

Juicy Excerpt: No, you don’t have to give back the things you bought with phony bull market gains. But you wouldn’t have bought most of those things at the prices offered had you known that you were not going to be able to retain all of your bull market gains. So you made bad purchasing decisions and bad financial planning decisions. How can anyone plan effectively without knowing the true numbers that apply? And you cannot go back in time and take those choices over once the price crash teaches you the realities. So bull markets do hurt even those who cash in their gains.