Set forth below are the words of a comment that I recently posted to Wade Pfau’s blog on the question of whether Valuation-Informed Indexing may not work in the future because the U.S. economy has been so damaged that it is not likely to recover:

What stage of the Roman (American) Empire have we now reached? Mr Bengen isn’t too sanguine in the interview.

It may depend on how hard we work to publicize the research of the past 30 years showing the effect of valuations on long-term returns, Canadian Investor.

I have been studying the valuations question full-time for over nine years now. The data shows that investors who consider valuations when setting their stock allocations reduce the risk of stock investing by close to 80 percent. Can you imagine the positive effect that would have on consumer confidence if we permitted word to get out to millions of middle-class investors? Millions of people would be able to realistically plan to retire many years sooner than is now possible. That would create a huge (real, not fake) spending stimulus.

The other side of the story is that we are indeed headed down to some very scary places if we continue to promote the investing ideas that became popular during the out-of-control bull market. The market was overpriced by $12 trillion in 2000. So we are in the process of seeing that much buying power disappear from our economy as prices work their way back to fair value levels. I doubt that any economy has ever survived such a hit.

And we shouldn’t be thinking that it is likely that the price drop will stop when we get to fair-value price levels. We have had three earlier out-of-control bulls. Following each of those, we went to price levels of one-half of fair value. The reason is that the return to fair prices causes such financial devastation that it brings on an economic crisis, and that depresses investors. If we go to one-half of fair value this time, that’s a price drop of 65 percent from where we are today. The hit we all will feel with those losses, coming on top of the losses we suffered during the first 12 years of recovery from the bull, would in all likelihood be enough to put us in the Second Great Depression.

My take is that we are the luckiest group of investors that has ever walked Planet Earth. Never have we known so much about how stock investing works. Never has any group of investors had the opportunity to earn such high returns while taking on such minimal levels of risk. But we will not realize that potential unless as a people we work up the courage to acknowledge that we did not know it all in the days when the Buy-and-Hold Model was being developed.

Learning new things always means letting go of wrong ideas in which we once held confidence. A lot of us are very reluctant today to permit the learning process required here to move forward. I have hopes that a deepening of the economic crisis may change attitudes and that within a few years we may all be enjoying the greatest years of economic growth we have ever seem.

This could be Game Over, but I don’t see any law that it has to turn out that way. As always, it appears to me that it is up to the humans to choose to take the high road or the low road! I put the odds at about 65 percent that we will work up the courage in time. I have seen signs in recent years that that is beginning to happen.

Rob