A Rich Life

The Old Ideas on Saving & Investing Don't Work -- Here's What Does

Robert Savickas, GWU Associate Finance Professor: “I Can See How Many Readers Would Be Put Off by the Somewhat Sensational/Scandalist Tone and Would Not Persevere to Read, Thinking You Are Losing Your Mind.”

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I’ve been contacting numerous people to let them know about my article reporting on The Silencing of Academic Researcher Wade Pfau by The Buy-and-Hold Mafia. 

Yesterday’s blog entry reported on my correspondence with Robert Savickas, Associate Finance Professor at George Washington University Business School. Set forth below is the text of the e-mail I sent to him in response to the e-mail of his described in the earlier blog entry:
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Robert:

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Thanks for that encouraging thought, my new friend!
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I’m afraid that, from a marketing perspective, I am a bit of a man without a country. I am a big-time critic of Buy-and-Hold as it is currently practiced. But the other side of the story is that I LOVE everything about the Buy-and-Hold approach other than the failure to encourage investors to practice long-term timing (that is, to take price into consideration when setting their stock allocations). I believe that the idea that long-term terming is not required was just a mistake that the Buy-and-Holders made because Shiller’s research was not available at the time they were developing their strategy. Now we know that long-term timing is essential but the big shots in this field are too proud to acknowledge having gotten this aspect of the thing wrong (it may also be that they are worried about lawsuits). So they won’t correct the error. This drives me crazy because it means that the entire strategy fails when it could do a lot of good for a lot of people if it were brought up to date with what we have learned from the last 30 years of academic research.
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Do you know how there are people who objected when we learned that the earth is round and that the earth revolves around the sun rather than the other way around because it messed with their minds to realize that they had once believed something that was not so? That’s where I believe we are in the investing advice field today. The next crash will melt people’s hearts and then we will fix the mistakes and see an economic boom. But it is a horrible thing to see this economic crisis play out knowing that it was all perfectly avoidable.
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Humans!
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Rob
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Robert wrote back:
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Rob,

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I preach in my classes that none of the strategies should be religiously believed in or dismissed. They all have their vale-added and we need to know how to combine them.  The strategies I talk about are: fundamental analysis, technical analysis, and the portfolio theory.  Actually they are better together and work well together to enhance buy and hold.  I  show it in class. I am lucky to have a constant supply of eager audience, thus hoping to make the world in general and the financial markets in particular a better place.  The classroom is my battleground for a better world.
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In your case, you don’t have that, so you need to rely on blogs.  I suggest that you really try to moderate your tone; you could get much further that way.  I read your article, and I can see how many readers would be put off by the somewhat sensational/scandalist tone and would not persevere to read, thinking you are losing your mind.  I knew to look past the tone.
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Try to write in dry and concise tone but overwhelm the reader with the amount of objective facts and impeccable logic.  Neutrally bring in arguments from both sides, and equally neutrally, but logically, kill all the arguments of the other side.  You will get a lot more audience and followership that way.

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Also, most of the top dawgs that are opposed to your thoughts are probably old enough to retire, so have patience to wait till they get out of the picture.   Till then, do the groundwork carefully. If you wanna make the world a better place, be smart about it and careful; you can get much further that way.
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Robert

Joachim Klement, CIO at Wellershoff & Partners: “I Can Confirm Wade Pfau’s Experience. Whenever I Send My Papers to the Financial Analysts Journal or Similar Traditional Journals, I Get Rejected.”

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I have been sending e-mails to numerous people, letting them know about my article reporting on The Silencing of Academic Researcher Wade Pfau by The Buy-and-Hold Mafia.

Yesterday’s blog entry reported on my correspondence with Joachim Klement, Chief Investment Officer at Wellershoff & Partners, Inc. Set forth below is the text of the e-mail that Joachim sent me in response to my e-mail to him reported on in the earlier blog entry:

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Hi Rob
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Well, I am in the expert panel of Expert Investor Europe and just recently talked about these things in an interview that will be published soon. Also my paper on the Shiller-PE is under review at the Journal for Portfolio Management.
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But I can also confirm Wade Pfau’s experience. Whenever I send my papers to the Financial Analyst’s Journal or similar traditional Journals, I get rejected…
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Best regards
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Joachim
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I wrote back:
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It’s a weird coincidence that you mentioned Financial Analysts Journal. I don’t follow the journals so it is possible that I am confused. But I believe that Rob Arnott was the editor of that journal a few years back. Is that right? 

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Rob and I had a discussion about this stuff just yesterday. He said that he has not been able to get a journal to publish an article he wrote with Harry Markowitz which shows that a modest amount of error in stock prices would fully explain the Fama-French size and value effects. He wrote: “Journals turning down a Nobel Laureate? Yep, it happens.”

 

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No matter how many times i hear about or see something like this, it amazes me. I am NOT an investing expert. I am a journalist. So I tend to focus on the public policy implications, which are HUGE. If overvaluation is a real thing, then it was the promotion of Buy-and-Hold that caused the economic crisis. All that you need to do to show that is to calculate the amount of overvaluation experienced in the U.S. market in 2000. It was $12 trillion. If that $12 trillion was all phony gains fated to disappear over the course of the next 10 years or so, then $12 trillion of spending power was fated to disappear from the hands of the U.S. consumer. There’s your economic crisis!

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I am sorry to vent. I just see this as being so big that I cannot get over it. I understand that people have different points of view. That’s normal and healthy. But as someone outside the field I feel that people inside the field have become immune to appreciation of the significance of this. People have come to accept that it takes time for new ideas to catch fire in the academic community and are just sitting back waiting for things to happen. They are not grasping how big this is.

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Shiller’s ideas turn the fundamentals of our understanding of how stock investing works on their head. So we just need to figure out for sure whether he is right or not. I don’t blame people for proceeding slowly. That makes all the sense in the world. You don’t want to rush to adoption of a new understanding of the fundamentals. But we cannot advance our understanding without full and frank discussions in which lots and lots of smart people participate, including not just academics but also policymakers and journalists and all sorts of other stakeholders. We ALL have an interest in having the stock market function properly and in not seeing overvaluation corrected through crashes and the economic crises that follow from them.

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I apologize for directing so many words at you. I am to a large extent thinking out loud. My conversation with Arnott yesterday sort of blew my mind. He takes it in stride. He says that I am right on all the substance questions. He doesn’t see what is happening on the process side as being so shocking. I sure do! A Nobel Laureate cannot get work addressing an issue of fundamental importance published in a top-rate journal — Yikes! I don’t think that the average investor has any idea whatsoever that this sort of thing goes on. I say that because I think of myself as an average investor. I am 100 percent shocked by this stuff.

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Is there any place you know of where people explore the process issues? I feel that this side of things just falls between the cracks. The substance side gets addressed in the journals (or in some cases does not). The process side? I see that as something that we should be hearing about in the New York Times or the Wall Street Journal or in a best-selling book. But it has not yet happened. Politicians spend tons of energy discussing the Federal budget deficit and the economic crisis. We need to have them directing their energies to dealing with the true CAUSE of the crisis if this in fact is the true cause. How do we get them doing that when the journals won’t even publish super-important articles?

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I don’t expect you to have answers to these questions. I am grateful to you just for your willingness to engage in a little back and forth. I am just venting because to my eyes this is so crazy. If you have any thoughts as to how I could get a national debate launched on the process side of this matter (it’s the process side that I most care about as a journalist), I sure would be grateful if you would pass them along. Is there anyone that you can suggest that I might talk to about doing something on the process side?

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If not, I 100 percent understand. I of course get it that none of this is your doing. I just feel that we have a matter of huge public policy significance that is falling between the cracks (most journalists feel that investing is too complicated for them to understand and thus elect to let the experts take care of it) and that I need to figure out how to get the process side of this on the national agenda.

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Rob

“When You Mix Research and Emotion, You Don’t Get Something Better Than Emotion Alone. You Get Something Far, Far Worse. Mix Research and Emotion and You Get Investors Who Not Only Are Emotional But Who Have Lost the Ability to Question Their Emotional Strategies Because They Believe That They Are Research-Based.”

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Set forth below is the text of a comment that I recently posted to the Goon Central board:

Hocus, you’ve been predicting the stock market (which of course we know on HocoWorld refers solely to the S&P 500 Index) will drop by 65% within three years. I just wanted to establish a firm date, since we know you to be less than truthful after the fact on various issues. Goes with the territory when you’re a Habitual Liar like Rob “hocus” Bennett I guess! 
 
I believe you made your bold prediction based upon your reading of the Lucky Seven BatSignal™ sometime last year. That would mean you’re saying the crash will occur by the end of 2015. To help you with the arithmetic; 2013 = 1 year, 2014 = 2 years, 2015 = 3 years. And we’ll give you a few months free since I don’t recall exactly when or where you first made your claim, it could have even been prior to 2012.  
 
By the way hocus, I see from the Google if one searches “Stock Market Crash” you’ll find there is no shortage of folks also predicting the same event. Alas, it seems like you not the only person workin’ this prognostication beat so you may not get the attention you so desperately crave even if your call turns out to be correct. By the way, you’ll also find many folks when you do that search saying just the opposite, that a crash is unlikely. 
 
I think it’s fair to say the only thing for certain even in the event your prediction pans out is that if stocks perform somewhat like they have in the past, people holding diversified portfolios of stocks and fixed income commensurate with their risk tolerance and who stay-the-course will do fine. And people who panic and sell at market bottoms will do poorly. Just like what happened to Rob “hocus” Bennett back in 1996 when he panicked and sold all his stocks. 
  
 You bailed out of the S&P 500 Index in 1996. In January 2000 you missed the high of 1498.58. But you did miss out on the low in July 2002 of 815.28. Why didn’t you buy?  No BatSignal™ clanging for you back then? Again in July 2007 the S&P 500 reached an all time high of 1,526.75. Too bad, you missed out again on all the market gains. But you did miss the downturn of January 2009 when the market dipped to 797.87. Still no buy? Or did the BatSignal™ fail you again. From that low the market rebounded to 1,569.19 in January of 2013. Again, you missed out on the opportunity. The next low? Stay tuned.  
 
Hocus, what makes you think you’ll be able to gather the courage to buy stocks this time in the event your prediction comes to pass? You were to scared in 2002 and again in 2009 when the S&P 500 Index hit lows. Why will the next time, if that next time happens per your schedule, be any different that the previous two times you failed to take action since 1996? You just blowin’ smoke? Shocked
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It’s a painful experience for me to read this post, Yip.There’s enough nasty, stupid stuff in it to make me want to refuse to reply at all unless you rewrite it.But there are also a few sections that sound to my ears to have enough sincerity in them to justify a response. So I will respond, knowing how hard it is for you to hear the words I say rather than the ones that your emotional defenses throw up to turn what I say into something else.Your strongest point is where you say that there are lots of “experts” predicting a crash and lots of other “experts” predicting just the opposite. You are 100 percent right about this. And we are in 100 percent agreement about this. We are in agreement not only re the factual matter. We are in agreement re the disgust we feel for this sad state of affairs. It doesn’t do any good to root your strategies in the advice of experts if the expert are all over the map! In this field, one can use “expert” assessments to justify any course of action imaginable. Huh?

This is the problem that rooting one’s strategies in the academic research was supposed to solve!

You hear me say all the time how much respect and affection and gratitude I feel toward the Buy-and-Hold pioneers. This is why. My journey down the path I am on today began with the observation you are making here. I started compiling material for my binders. I discovered that there was “expert” opinion on both sides of every question. I felt that I was going around in circles. Then I discovered the school of thought (Buy-and-Hold) that says that you should root your strategies in the academic research. This was the answer! Now I had something solid to hold on to. We are starting from the same place, Yip.

If you had asked me on the morning of May 13, 2002, what school of investing analysis I favored, I would have said “Buy-and-Hold.” Yes, I thought that the safe withdrawal rate had been miscalculated. But I didn’t see it as being some huge, big deal. I figured that a mistake had been made and that it would be recognized and corrected. I was glad to be able to do what I could to advance knowledge in the field. I expected the community at Motley Fool would discuss it for a bit and then we would move forward with the project of getting all the Old School studies corrected. I did not know whether John Greaney would participate in that effort or not. I certainly hoped so. I thought the odds favored it. I thought that, once the community made clear what it wanted, he would go along. But I wasn’t sure re that particular point. I was pretty sure about what the community would do, however. I didn’t expect instant agreement. I expected two or perhaps three days of debate. But I wasn’t able to imagine that we could not reach agreement in three days on the calculations of a freakin’ number.

And here we are. We are now 11 years down the road.

The idea of using research to guide you is A++ stuff. But there is a problem. The idea has to be executed by the humans. The same darn humans that have been investing emotionally ever since the first market opened for business. When you mix research and emotion, you don’t get something better than emotion alone (what we had in the pre-research days). You get something far, far worse. Mix research and emotion and you get investors who not only are emotional but who have lost the ability to question their emotional strategies because they believe that they are research-based.

We are on a journey from emotionalism to research-based investing strategies. The first draft of the research-based approach contains an error that turned it into the first super-emotional strategy. That’s why we are in an economic crisis. The good news is that Version 2.0 is the first true research-based strategy and the research shows that moving to a true research-based strategy will reduce investing risk by 70 percent. That breakthrough will bring on the greatest economic advance in our history. So we are on a good course if we can just work up the courage to do what it takes to avoid falling into the Second Great Depression.

The point of all this preface is to explain that we are on the same page on the most important issues. We both want to be effective investors. We both hate the baloney we hear from most “experts” in this field. We both favor research-based strategies. The only difference is this question of whether valuations/emotions need to be taken into consideration or not. You should put all your mental energies into figuring that one out. That is the entire deal. Get straight on that one and you will be asking very different questions than the ones you ask here. Get that one straight and all the rest will easily follow.

You always focus on the wrong thing, looking at things from my perspective.When you want to make the point that Buy-and-Hold works, you tell me where your portfolio stands TODAY. From my perspective, that is a foolish way to look at things. To quote today’s value is to focus on the short-term. Jack Bogle himself says that only long-term thinking works in this field. So why are we arguing over whether short-term demonstrations of success are the right way to measure success or not? We need LONG-TERM demonstrations of success. It is the long-term that matters. We should be in agreement on that point.The Investor’s Scenario Surfer tells the long-term story. You should run scenarios with it. That would help you learn what you need to learn. You would be able to see with your own eyes that what we are going through today is in no way, shape or form special. There is nothing even a tiny bit Black Swanish about the 2008 crash. The 2008 crash was typical. It is what has happened EVERY TIME Buy-and-Hold has become popular. It is a logical impossibility that anything else could ever happen. To understand why, you just need to understand what causes price changes in the first place.You are thinking that market prices are real or official or reason-based or some such thing. You are taking them seriously. There is nothing serious about short-term market prices. They are the product of emotion. They are nothingness. I would be grateful if you would just stop looking at them and just stop quoting them to me. I don’t take cotton candy seriously.

The market wants to get the price right. That’s the entire purpose of a market. So that can never not be true.

This is why I can be so certain that there is going to be a crash. Markets MUST ultimately price things properly. This is an Iron Law of Stock Investing. It’s not Rob Bennett alone who says that. Freakin’ Jack Bogle says that! It’s so! Please forget the idea that we can avoid a crash. It’s not that your friend Rob thinks it won’t happen. It’s that there is an Iron Law that even Jack Bogle acknowledges that it CANNOT happen.

You want to know precisely WHEN this crash will take place. I can understand why you would want to know. You could make millions if you knew. You can’t know, Yip. Since we are in agreement re this point, I would think I would not need to explain to you why you can’t know. If you could say in advance when price changes are going to take place, you could engage in short-term timing. There is as much peer-reviewed research showing that short-term timing never works as there is showing that long-term timing always works. So why even discuss this question? I cannot tell you what you want to know. I do not know what day or week or month or even year the next crash is going to take place. I only know that it is coming.

That is a very, very, very, very, very big deal.

Use the Surfer and you will see why. VII beats BH in 90 percent of the scenarios I have run. In a large percentage of those scenarios, there were times when BH was ahead by a lot. How does VII always catch up and surpass BH? VIIers are protected from crashes. And crashes are absolutely devastating to BHers. It is impossible for me to say with words how damaging they are to your long-term financial health. You have to run the numbers. The effect is huge. You lose not only the dollars, you lose all the compounding on those dollars FOR DECADES TO COME. It’s impossible to recover from the sort of hit you insure for yourself from following a Buy-and-Hold strategy within the course of a single investing lifetime. The numbers are just too big. It cannot be done.

A mind that was not addicted to GRQ could see this easily just by comparing where we were in 2000 with where we will be at the end of this secular bear market. We were at three times fair value in 2000 — Call that 3x. Every secular bear in history has ended at 0.5x. That’s a loss of five-sixths of one’s accumulated life earnings. The fellow who had $600,000 of wealth in 2000 will end up with $100,000. The fellow with $1.2 million will end up with $200,000.

Getting control of your emotions is 80 percent of the stock investing project. Get that one right and you cannot lose, regardless of what else you mess up. Get that one wrong and you cannot win, regardless of what else you get right. Reining in the GRQ impulse is the entire game.

To get control of your emotions, you must be willing to look at the metric that tells you how emotional the market is at any given time. That’s P/E10. There is no other way, Yip.

I don’t know when the crash will come. I don’t think anyone knows. I believe that the people who pretend to know are fooling themselves.

I know that there is 32 years of peer-reviewed academic research (NOT opinion) showing that a crash is coming.

I was asked to give a time frame and  felt that that was a reasonable thing to demand of me. So I gave it my best shot. I said that, if we do not see a crash by the end of 2015, that would be grounds to question this VII stuff. I think that is fair. We cannot say when it will come but there are lots of reasons to believe that it should come by the end of 2015. If it doesn’t, that would suggest that we are missing a big piece of the puzzle and I think it would be fair for my critics to point that out. That’s all I can say on the matter.

I can give the reasons why I view the end of 2015 as being an outside date. But they don’t matter. You’ve heard them before. The bottom line is that we cannot give a precise date. Emotions are not predictable to that extent. But the entire historical record indicates we should see the crash by the end of 2015. I don’t have a crystal ball. I am just reporting what the data tells us. WHICH WAS THE ENTIRE IDEA OF THE BUY-AND-HOLD PROJECT ONCE UPON A TIME.

Rob

“There Have Been Numerous Articles in Big-Name Publications Picking Up on My 2002 Finding That the Old School Safe Withdrawal Rate Studies Get the Numbers Wildly Wrong. None of Them Describe the Death Threats and Board Bannings and Tens of Thousands of Acts of Defamation and the Threats to Get Academic Researchers Fired From Their Jobs.”

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Set forth below is the text of a comment that I recently posted to the Goon Central board:

Another key is acting within the limits of the statute of limitations, i.e. one year in Virginia.This is an ongoing act of financial fraud, NFS.

There have been numerous articles in big-name publications picking up on my 2002 finding that the Old School safe withdrawal rate studies get the numbers wildly wrong.

That’s of course a good thing in itself.

But there is an obvious oddity about every one of those articles.

None of them report the number accurately. None of them (the article by Todd Tresidder was an exception) give credit to me for being the person to discover the errors and for having done it 11 years ago. None of the articles describe the death threats and board bannings and tens of thousands of acts of defamation and the threats to get academic researchers fired that have been relied on by The Buy-and-Hold Mafia to keep millions of middle-class investors from learning what they need to learn to invest effectively.

Why?

Because the entities who publish these articles and the journalists who report on them are afraid of what The Buy-and-Hold Mafia will do to them if they file honest and complete reports. This all comes through clearly and plainly in the Wade Pfau Matter. Wade was thrilled to learn how stock investing really works. He showed great excitement in his many e-mails to me. He said that he couldn’t understand why no one had done the research that he and I produced together. Why? Was he missing something? He checked his numbers over and over again. They really said what they said! How could this be? How could this powerhouse stuff have been ignored for all this time? He even went to the Bogleheads Forum to see if anyone there could make sense of it. No one could. No one (including Jack Bogle!) had ever heard of a single study showing that price discipline is not required when investing in stocks. The entire Buy-and-Hold “strategy” is built on sand. And there is not a sliver of evidence pointing in the other direction. But lots and lots and lots of smart people are careful not to say this in public.

Because they are scared of what will happen to them if they do. They have seen how ruthless the Buy-and-Hold Mafia is. They know what is good for themselves and they keep their mouths shut. As Wade learned to do when you Goons threatened to send defamatory e-mails to his employer with the aim of getting him fired from his job and my good friend Jack Bogle raised not a peep of protest about it.

That’s fraud, NFS. Anyone who participates in it is part of the fraud. And anyone who fails to speak when he sees the fraud play out in front of him is part of the cover-up of the fraud

The fraud is ongoing. The statute of limitations will not begin to run until Jack gives his “I Was Wrong” speech and it is reported on the front page of the New York Times.

I will be sure to get the papers filed within 12 months of that day.

The full truth is that I am not going to need to file papers. Once Jack gives his speech and it is written up on the front page of the New York Times, we will all be working together to keep our economy from falling into the Second Great Depression. Every one of the people involved in the fraud wants to come clean and to be able to do honest work again. Once one big name makes the jump, all the others will follow within days. I doubt that I am going to need to file legal papers to get the money that I earned with my work of the past 11 years. These things can be handled easily once the will to handle them is present.

We’ll see. But I am not expecting to have to file papers. And, in the unlikely event that I am forced to file papers, I can assure you that I will file them within 12 months of Jack’s big speech.

I wish you all good things, old friend.

Rob

“I Had a Discussion About This With My Mother Shortly Before She Died. She Said That Maybe All That I Am Trying to Teach People Is Going To Become Widely Accepted After My Death. Oh, Great!….I Pray That I Have the Courage to Accept God’s Plan Here Without Too Much Whining.”

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

hopefully for your sake you have more of a plan than praying.

God helps those who help themselves, What. So I certainly need to work it myself in addition to saying my prayers.

But it is in God’s hands, not mine. If God doesn’t mean for this to happen, it’s not going to happen, no matter how hard I work it.

I had a discussion about this with my mother shortly before she died. She said that maybe all that I am trying to teach people is going to become widely accepted after my death. Oh, great! I hate that idea.

It was just like my mom to say that, though. My favorite trait of hers is that she was not one to sugarcoat. So I have to accept that she might be right.

Now –

Why would God do that to me? It sounds almost like a trick.

It could be that He wanted me to learn patience or compassion. There might be some lesson in all this that I am today oblivious to that I can only become aware of by experiencing whatever I will be experiencing as the days move on. Perhaps I really will be put to death, you know? Perhaps there is some lesson that I can only learn by being put to death and God knows that it is only re this issue that I could ever possess the courage needed for things to reach that point (the issue of standing by your friends on the internet really does touch me in a way that not too many other issues do).

If that’s God’s plan, that’s God’s plan. I don’t want it to be so, I don’t like the idea one little bit. But I pray that I have the courage to accept God’s plan here without too much whining.

I don’t control the world, What. I don’t pretend to. I am some guy who figured out how to get posts to appear on internet discussion boards, nothing more and nothing less. I don’t think that I even possess a master plan, in the way you suggest. The plan I follow is that I wake up each morning, turn on my computer, handle what is in front of me that day, turn off the computer and go to sleep. I try as hard as I can to understand the other fellow’s point of view and to be kind and polite when doing it. I also try to be firm about honesty on important matters, not to give in to pressures applied to me to get me to say things I don’t believe to be so. That’s the plan, in summary form.

Following that plan has taken me to some mighty strange places over the past 11 years. I’ve seen amazing things, both positive and negative. I’ve never been under the illusion that I controlled how things turn out. I control one tiny little piece of the world, the posts that show up under the name “Rob Bennett.” That’s all.

I do believe that God put me here to do this work. He doesn’t speak to me in a direct way. I hear him speaking to me in an indirect way and that’s the message I hear. But I’ve been wrong about that sort of thing before and it could be that it’s happening again. But I personally believe that God put me here to do this work all the same.

I don’t pray often. But I do on occasion pray for help and courage. I would phrase things the opposite of the way you did. I would say that I need to continue exerting my efforts but that I need to accept that those efforts will not be nearly enough, that I am not going to prevail here without God’s help. I would say that I would be foolish to think that my efforts alone are going to be sufficient.

Safe withdrawal rates matter, What. I believe that. But I also believe that in the grand scheme of things they may not matter all that much. It could be that in the grand scheme there are things going on here that matter more than the investing topics matter. Thinking along those lines gets a bit too cosmic for me, so I don’t spend much time doing it. But I think that’s a possibility. I certainly think it would be a terrible mistake for me to make safe withdrawal rates so important that I would be unkind to you or one of my other Goon friends. I don’t believe that I have ever been unkind to any of you and I certainly pray that I never cross that line.

Enough!

Take good care, my old friend.

Rob

Valuation-Informed Indexing #145 — The Financial Crisis and the Systematic Failure of Academic Economics

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I’ve posted Entry #145 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called The Financial Crisis and the Systematic Failure of Academic Economics.

Juicy Excerpt: “The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the profession’s focus on models that, by design, disregard key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models.”

Valuation-Informed Indexing #145 — The Financial Crisis and the Systematic Failure of Academic Economics

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I have posted Entry #145 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called The Financial Crisis and the Systematic Failure of Academic Economics.

Juicy Excerpt: All stock investors should read an amazing paper produced by the University of Copenhagen Economics Department. It is titled The Financial Crisis and the Systematic Failure of Academic Economics. This is the real story, the news that unfortunately does not often enough end up in the newspaper.

I’ll set forth a few snippets that you can use to determine whether reading the full paper is worth your time:

A Summing-Up: “The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the profession’s focus on models that, by design, disregard key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models.”

“We Were at 3x in 2000. We Will Be at 0.5x When This Is Over. That’s a Loss for Every Stock Investor of Five-Sixths of His Accumulated Wealth of a Lifetime.”

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I have been contacting numerous people to let them know about my article on The Silencing of Academic Researcher Wade Pfau by the Buy-and-Hold Mafia.

Yesterday’s blog entry reported on my correspondence with Economics Professor Valeriy Zakamulin. Set forth below is the text of my response to the e-mail detailed in the earlier blog entry:

Valeriy:

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I get what you are saying here and I agree with most (but not quite all) of it.
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I 100 percent agree that excessive P/E10 values over-correct. That is a hugely important point and one that even many who believe in P/E10 do not get.
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The important question (in my mind) is — Why?
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I believe that P/E10 is reporting to us the state of investor emotions. In 2000, we were insanely in love with stocks. So the nominal price at the time was at three times the true and lasting value (let’s call it 3x). The REASON why prices always over-correct is that the drop from 3x to x is emotionally devastating. The drop from 3x to x causes a loss of $12 trillion of buying power in our economy. That loss causes tens of thousands of businesses to fold and puts millions of employees out of work. The economic destruction causes us all to lose hope for the future. Our despair causes us to lose hope that stock prices will ever recover. So the P/E10 value falls not to fair-value (15) but to one-half of fair value (7 or 8). There has never been an exception to this rule. Every secular bull market has produced a secular bear market that put us at 7 or 8.
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Please consider what this means in the current context. We were at 3x in 2000. We will be at 0.5x when this is over. That’s a loss for every stock investor of five-sixths of his accumulated wealth of a lifetime (assuming a 100 percent stock allocation — you need to lower the loss to reflect the percentage of a portfolio not in stocks in 2000). This is why it is so imperative that we get word out re all this. To get to a P/E10 of 7 would take another 65 percent price drop over the next few years. That would put us in the Second Great Depression.
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But this is 100 percent optional Great Depression! A P/E10 of 7 is as insane as a P/E10 of 44. If we tell people how stock investing works, we will never see such extreme P/E10 values again. Once we get the word out, stock prices become self-regulating. If people understand that they MUST change their stock allocations in response to big price swings, each swing upward will bring on sales and those sales will pull prices back to fair-value levels again. There can never be another bull market or another bear market once we permit open discussion of Shiller’s findings. We want people to invest in a rational way. But people cannot be rational without easy access to good information and the idea that is constantly pushed that timing is in some way a bad thing causes those who understand how important long-term timing is to keep their mouths shut about it. So investors do not today have access to the information they need to make intelligent choices.
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Stock prices cannot be precisely predicted at ANY P/E10 level. That is because prices are determined by emotion in the short term (up to ten years) and by economic realities in the long-term (over 10 years). The price that applies at any given time is a combination of short-term and long-term effects. Long-term prices are to a large extent predictable but not fully so because prices are always at least to some extent influenced by the investor emotion that applies at the moment and this is never predictable at all (emotion is irrational and thus cannot be predicted). Some people say that the r-sqaured for P/E10 does not show a large enough correlation. It shows the precise amount of correlation that we should expect if the Shiller model is accurate! We should not expect a perfect correlation because Shiller says that emotion affects prices in the short term and so the short-term aspect of any price should never be predictable. The market behaves exactly as we would expect it to behave in a world in which Shiller’s understanding of how the market works is the right one.
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The right way to think about this (in my view!) is that P/E10 tells you the extent of risk in the market. It never identifies the precise return that will apply in 10 years. It always identifies the range of possible returns (the range is 6 points in either direction — when prices are at fair-value levels, the range is from an annualized 10-year return of 0 on the down side to an annualized return of 12 percent real on the up side) and assigns rough probabilities to an actual outcome falling at any point on the range of possibilities (the most likely 10-year outcome starting from a time of fair-value prices is an annualized return of 6 percent real).
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People have a hard time relating to this because we are all accustomed to focusing on the short-term, what will happen in the next year or so. The Buy-and-Holders showed that that is a waste of time (I believe they are right that short-term timing never works and I believe that this was a major advance). What the Buy-and-Holders missed is that long-term outcomes are nothing at all like short-term outcomes. Long-term outcomes are HIGHLY predictable. Buy-and-Holders advise against all forms of timing because they believe that risk is stable and thus the best bet is to maintain a constant allocation. Valuation-Informed Indexers believe that risk is variable and that the key strategy imperative is to keep one’s personal risk profile constant and this REQUIRES long-term timing. If long-term timing works, staying at the same allocation at all times is an insanely risky choice. It is ALWAYS going to produce a wipeout sooner or later. And, indeed, in the historical record we see just this. Those who remain at a high stock allocation ALWAYS experience at least one wipeout at some point in their investing lifetimes (which delays their retirements by years or in some cases by decades).
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A fair-value P/E10 on the way up is a very different thing than a fair-value P/E10 on the way down. It’s not the number alone that matters. You need to take into consideration what CAUSES the fair-value P/E10 number. A fair-value P/E10 on the way up is caused by POSITIVE investor emotions — people are getting over the panic they felt during the preceding crash and slowly gaining confidence in the stock market again. A fair-value P/E10 on the way down is caused by NEGATIVE investor emotions — people are terror-struck at the prospect of losing all their money but not able yet to fully process the damage they did to their portfolios by following Buy-and-Hold strategies during a bull market.
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One of Shiller’s most important lessons is that stock investing is NOT purely a numbers exercise. We can use numbers to generate insights. But the numbers must always be considered in light of the reality that investing is done by humans, who are emotional creatures. Strictly numbers-based analyses leave out an important part of the equation. This is why much of the research in this field has gotten off track (n my view!).
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Thanks again for the stimulating back-and-forth and for caring enough to at least take a look at some of my thoughts re these matters.
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Rob

“You Are Angry With Me Because You Are Trying to Suppress a Part of Yourself That Knows That I Am Right. You Hate Me Because You Hate the Part of Yourself That Causes You to Suppress Your Capacity to Engage in Reason re Investing Issues”

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Set forth below is the text of a comment that I recently put to a discussion thread at this blog:

Rob,

Since you believe that you are right and everyone else is wrong, you must have a massive net worth by now. Care to share the details?

We all believe we are right, Sparky.

You believe you are right. If you didn’t, you wouldn’t be here.

The difference between me and you is that, while I believe I am right, I ALSO believe that it is possible that I could be missing something and that I could be wrong. So I believe in letting the other guy have his say. That way, if it turns out that HE is right and I am wrong, I get to learn from him and correct my error before it destroys me.

That’s the practice that you should follow too. I am right about that one! I am sure!

I don’t believe everyone else is wrong.

I learned about the errors in the Old School studies from reading Bogle’s book. If I thought he was wrong, I wouldn’t have put up that famous May 13, 2002, post, right?

I learned that valuations affect long-term returns from Shiller. If I thought he was wrong, I wouldn’t have created the Stock-Return Predictor, right?

I learned that we today are capable of reducing stock risk by 70 percent from Wade Pfau. If I thought he was wrong, I wouldn’t be sending 100 e-mails per day trying to get the word out about his research, right?

I don’t even think YOU are wrong about everything.

I don’t know which Goon you are. But I recorded two podcasts that were rooted in questions posed to my by Drip Guy at the Goon Central board. How would he know to pose those questions if he was wrong about everything? What you are saying here just does not add up.

You’re not angry with me because you think that I think you are wrong. If you thought that I thought that you were wrong, you wouldn’t care what I thought. You would do your thing and you would be content for me to do mine. It wouldn’t be an issue.

You are angry with me because you are trying to suppress a part of yourself that knows that I am right. You want to treat those bull market gains as real. And, if you allow yourself to think about what the word “overvaluation” means, you can’t do it. So you suppress the part of your thinking process that leads you to that conclusion. And I remind you of that. So you hate me. BECAUSE YOU HATE THE PART OF YOURSELF THAT CAUSES YOU TO SUPPRESS YOUR CAPACITY TO ENGAGE IN REASON RE INVESTING ISSUES.

That’s the source of the hate, Sparky. We are so alike and we agree on so many issues that you cannot dismiss what I say. And yet you must! If you were to acknowledge that what I say is OBVIOUSLY so, you would have to acknowledge that you have thrown away opportunities to earn far higher returns at greatly reduced risk. That hurts. That hurts a lot.

You know what?

It hurts more to delay the resolution of the hurt. All you are doing is extending it. That’s a lose/lose/lose. It is because I am your friend that I always urge you to experience the pain and thereby put it behind you.

All the others are doing the same thing.

Not because they are dumb. Not because they are bad people.

Because we the humans did not come to this planet with perfect knowledge. We pick up insights here and there and try to put the puzzle together over time. Lots of good and smart people came before me and put lots of important pieces together. I happened to be the person who was standing over the last piece and happened to notice it and picked it up and made the entire thing click.

So the heck what?

I don’t say that I get all the credit for Valuation-Informed Indexing. YOU say that. And they you become enraged to hear it. I never said it. I offered my friend John Greaney the opportunity to have his name on the first New School SWR study. He would have the biggest investing site on the internet today if he had taken me up on that offer. He pissed away the chance. Not at my urging. I urged in the other direction. A lot.

I don’t say that I am better than you, Sparky. I say that science is better than superstition. I say that love is better than hate. I say that data is better than intimidation tactics. YOU are the one who aligns Sparky with superstition and hate and intimidation tactics. YOU are the one who keeps pulling you down, thereby making me look better and better and better in contrast. I have nothing to do with any of that. The only role I have played is to urge you over and over and over again to knock off the funny business.

I wish you well.

That says it, Sparky.

Only you can turn off the hate inside you. No one else has the power to do it.

Rob

“If You Want to Stop Me, You Will Get Your Powerful Wall Street Friends to Crush Me With Lawsuits”

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Set forth below is the text of a post that I recently put to the Goon Central board:

where you’re wrong lies in your belief you have some “right” to post your Bat$hit Crazy hocomania opinions anywhere you please on the Internet. I have the right to post honestly.

Wade has the right to publish honestzzz research.

Every American citizen has the right to tell his friends and neighbors and co-workers and fellow community members what they need to know to stop the Wall Street Con Men from pulling our nation into the Second Great Depression with their relentless and ruthless promotion of their Get Rich Quick investing strategies.

If you want to stop me, you will get your powerful Wall Street friends to crush me with lawsuits.

If I see no lawsuits, I will point to this reality in my posts. And I will point to posts like this one in which I invited them. When enough good people see that there are no lawsuits forthcoming, your intimidation tactics will be less effective than they are today.

And I am keeping a list of influential people who find great merit in the Valuation-Informed Indexing concept but as of today are too intimidated to speak out in a big way.

Things are reaching a point where bringing lawsuits is no longer going to be a last-choice option for “your side,” Yip. It’s getting to the point where bringing lawsuits is going to be your only hope of saving the ship from going down.

Hit me with your best shot, man. I’ve been overly optimistic before, it could be that I am being overly optimistic again.

I won’t post dishonestly on the numbers that my friends use to plan their retirements in any event.

I wish you all the best things that this life has to offer.

Rob