It's pretty easy to curve fit a basic stop system to get massive returns... But with such a pathetic sample, like the 10 or so entries/exits, I wouldn't have any confidence in it.
There really isn't anything wrong with buy and hold, as long as you aren't "all in" like all the financial rags tell the 20-35 year olds to be.
I can feel comfortable buy and holding equities as part of the permanent portfolio for example.
Is Buy-and-Hold Just a Marketing Pitch?
@Jacob Thanks! Now I understand your numbers. 
I've been intrigued by Shiller's PE10 and the Dow/gold ratio for a while now.
They're impressive and I hope they're not cases of "if it looks too good to be true...". I hesitate about how much weight to attach to them. Harry Browne described on pages 189 and 190 of HTBLPGW how people lost big using the gold/silver ratio and the CHF/DEM ratio. He warned: "Spread systems are based on the unstated assumption that the world doesn't change. But the world is in contant change - as values change, demand changes, supplies change. Otherwise there would be no price movements for investors to try to exploit. A price ratio that goes to a new high isn't necessarily due for a fall. The weaker investment doesn't have to "catch up" - ever. The ratio's new high may reflect a fundamental change in technology or in the values of consumers. We might never again see the old high - let alone the old low."
Another criticism I've heard is that the predictive qualities of statistics about extremely low PE10 values are limited, as the sample size is extremely small.
But I remain fascinated! Looking forward to finding out more about these things and others like it, like a real estate/gold ratio, etc.
I've been intrigued by Shiller's PE10 and the Dow/gold ratio for a while now.
They're impressive and I hope they're not cases of "if it looks too good to be true...". I hesitate about how much weight to attach to them. Harry Browne described on pages 189 and 190 of HTBLPGW how people lost big using the gold/silver ratio and the CHF/DEM ratio. He warned: "Spread systems are based on the unstated assumption that the world doesn't change. But the world is in contant change - as values change, demand changes, supplies change. Otherwise there would be no price movements for investors to try to exploit. A price ratio that goes to a new high isn't necessarily due for a fall. The weaker investment doesn't have to "catch up" - ever. The ratio's new high may reflect a fundamental change in technology or in the values of consumers. We might never again see the old high - let alone the old low."
Another criticism I've heard is that the predictive qualities of statistics about extremely low PE10 values are limited, as the sample size is extremely small.
But I remain fascinated! Looking forward to finding out more about these things and others like it, like a real estate/gold ratio, etc.
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RobBennett
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"with such a pathetic sample, like the 10 or so entries/exits, I wouldn't have any confidence in it."
I agree that it would be good if we had more data, Johnny. We only have what we have, though. There's nothing we can do about it.
The only point that I would make here is that those saying we don't need to change our allocations in response to price swings are using the same limited data to support their claims. So we should properly show the same skepticism toward claims of Buy-and-Holders.
If we got to a point where we showed skepticism toward all investing theories, I think that would be great. I cannot help but have my own beliefs, like everybody else. But I think there is a great danger in becoming too sure of yourself re investing issues. My view is that everybody's knowledge is at a primitive stage of development today and it would be good if people on all sides of every question would make an effort to express more humility. Everyone (very much including me) is just putting ideas forward. No one knows for sure.
Probably my biggest gripe with the Buy-and-Holders is that they just come off sounding too sure of themselves. They talk as if what they do is science when its really not much more than guesswork (again, this is true of non-Buy-and-Holders as well). I think the problem here is that it scares people to invest their money pursuant to shaky theories. So people want to hear great confidence even though it is unwarranted given the limited data set. Humility is what works but bravado is what sells.
Rob
I agree that it would be good if we had more data, Johnny. We only have what we have, though. There's nothing we can do about it.
The only point that I would make here is that those saying we don't need to change our allocations in response to price swings are using the same limited data to support their claims. So we should properly show the same skepticism toward claims of Buy-and-Holders.
If we got to a point where we showed skepticism toward all investing theories, I think that would be great. I cannot help but have my own beliefs, like everybody else. But I think there is a great danger in becoming too sure of yourself re investing issues. My view is that everybody's knowledge is at a primitive stage of development today and it would be good if people on all sides of every question would make an effort to express more humility. Everyone (very much including me) is just putting ideas forward. No one knows for sure.
Probably my biggest gripe with the Buy-and-Holders is that they just come off sounding too sure of themselves. They talk as if what they do is science when its really not much more than guesswork (again, this is true of non-Buy-and-Holders as well). I think the problem here is that it scares people to invest their money pursuant to shaky theories. So people want to hear great confidence even though it is unwarranted given the limited data set. Humility is what works but bravado is what sells.
Rob
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RobBennett
- Posts: 120
- Joined: Wed Aug 11, 2010 8:09 pm
- Contact:
"I can feel comfortable buy and holding equities as part of the permanent portfolio for example."
I believe that this is a reference to Harry Browne's Permanent Portfolio concept, in which investors own 25 percent equities, 25 percent gold, 25 percent cash and 25 percent bonds. I agree that sticking with a steady stock allocation makes sense in this context. Browne created an alternative way for investors to protect themselves from price crashes. He was aiming to do what some are trying to do through consideration of valuations through a different means (he was essentially trying to provide protection by providing a greater measure of diversification than is achieved with just a stocks/bonds mix).
I see a lot of theoretical appeal in the Permanent Portfolio concept. I didn't elect to go with it but it could be that it is a better approach than mine.
Rob
I believe that this is a reference to Harry Browne's Permanent Portfolio concept, in which investors own 25 percent equities, 25 percent gold, 25 percent cash and 25 percent bonds. I agree that sticking with a steady stock allocation makes sense in this context. Browne created an alternative way for investors to protect themselves from price crashes. He was aiming to do what some are trying to do through consideration of valuations through a different means (he was essentially trying to provide protection by providing a greater measure of diversification than is achieved with just a stocks/bonds mix).
I see a lot of theoretical appeal in the Permanent Portfolio concept. I didn't elect to go with it but it could be that it is a better approach than mine.
Rob
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RobBennett
- Posts: 120
- Joined: Wed Aug 11, 2010 8:09 pm
- Contact:
"TIPs & I-Bonds had great yields in the late '90s. Not so much now."
This is of course indeed so.
"The vast majority of stocks may still be overvalued, but careful research will lead to investments that yield a decent ROI relative to inflation. I buy dividend stocks to participate as an owner in the FCF of the business."
This makes sense to me. I think it is worth noting that the effect on the economy is very different when an investor seeks out good buys and when an investor buys index funds without concern for price. The former investor is helping the free market to work by rewarding well-run companies and punishing poorly run companies; the smart dividend investor is helping the Invisible Hand of Capitalism to do its thing. This is very much not the case with the passive Buy-and-Hold Investor. The Passive Buy-and-Holder is exacting no penalty whatsoever on overpriced companies.
We rarely see anyone focus on this aspect of the question. But I think it is of huge importance. What has happened historically is that we became a sufficiently rich people that the middle-class for the first time became stockholders. We needed a simple approach to investing for them. Bogle came up with one, to his credit. But because the Efficient Market Theory happened to be in vogue at the time he did so, he neglected to include in his program a requirement that the investor change his stock allocation in response to big price swings. This was a fatal mistake. What he did was to take all price discipline out of the market. No market can function indefinitely without price discipline.
Think what would happen if the purchasers of cars stopped caring about price, if everyone adopted a "Cars for the Long Run" policy of paying whatever price was asked by the dealer without questioning. The average price of cars would go from $30,000 to $60,000 to $120,000 to $240,000 and on and on until the entire economy cratered because no one had money for anything but car purchases. This is what happened with stocks in the 1990s. When you take price discipline out of the market, you are cutting the brakes out of a fast-running car. A car without brakes always crashes sooner or later. It is just a matter of time.
A market needs to have some means to adjust prices downward when appropriate. It can be done through the education of investors. Or it can be done through price crashes. Price crashes are an incredibly inefficient means of doing the job because they cause massive unemployment and political unrest and business failures and broken marriages and a hundred other bad things. The far easier way to do this would be just to let investors know that valuations affect long-term returns and that everyone needs to consider this when setting his or her stock allocation.
The ONLY reason why a valuation component was not included in the first draft version of the Buy-and-Hold package is that the Efficient Market Theory was popular at the time and it wasn't understood how important the valuation component was to making the thing work in the long term. Now we know. So we should go back and make the necessary fix. All that Valuation-Informed Indexing is is Bogle's Buy-and-Hold with a valuation component added. But that makes a big difference. Buy-and-Hold is always going to cause massive economic collapses because it takes price discipline out of the market while VII would provide a means for middle-class people looking for a simple way to participate in the stock market to do so without doing any damage to the overall economy.
I believe that all of the "controversy" over these matters is political in nature. There is no economic argument today that valuations do not affect long-term returns (the Efficient Market Theory was discredited a long, long time ago). All of the economic suffering we are living through today is just because the Big Shots who came up with this idea cannot bear to acknowledge that they made a mistake in failing to include a valuation component in the package.
I don't say that to hurt anyone's feelings. I say it because I see this economic crisis as a serious thing and I think that people need to get serious about responding to it and so far I don't see too many people talking about the real problem. Stocks were overvalued by $12 trillion in 2000. We knew that money was going to disappear. Overvaluation always disappears. Even Bogle acknowledges this. So we knew in 2000 that we would be suffering an economic collapse sometime over the next 10 years. We should have dealt with the problem then.
Now that it is too late to deal with it then, we should deal with it now. We are all better off with a functioning economic and political system. It is amazing to me that such points even need to be argued.
Rob
This is of course indeed so.
"The vast majority of stocks may still be overvalued, but careful research will lead to investments that yield a decent ROI relative to inflation. I buy dividend stocks to participate as an owner in the FCF of the business."
This makes sense to me. I think it is worth noting that the effect on the economy is very different when an investor seeks out good buys and when an investor buys index funds without concern for price. The former investor is helping the free market to work by rewarding well-run companies and punishing poorly run companies; the smart dividend investor is helping the Invisible Hand of Capitalism to do its thing. This is very much not the case with the passive Buy-and-Hold Investor. The Passive Buy-and-Holder is exacting no penalty whatsoever on overpriced companies.
We rarely see anyone focus on this aspect of the question. But I think it is of huge importance. What has happened historically is that we became a sufficiently rich people that the middle-class for the first time became stockholders. We needed a simple approach to investing for them. Bogle came up with one, to his credit. But because the Efficient Market Theory happened to be in vogue at the time he did so, he neglected to include in his program a requirement that the investor change his stock allocation in response to big price swings. This was a fatal mistake. What he did was to take all price discipline out of the market. No market can function indefinitely without price discipline.
Think what would happen if the purchasers of cars stopped caring about price, if everyone adopted a "Cars for the Long Run" policy of paying whatever price was asked by the dealer without questioning. The average price of cars would go from $30,000 to $60,000 to $120,000 to $240,000 and on and on until the entire economy cratered because no one had money for anything but car purchases. This is what happened with stocks in the 1990s. When you take price discipline out of the market, you are cutting the brakes out of a fast-running car. A car without brakes always crashes sooner or later. It is just a matter of time.
A market needs to have some means to adjust prices downward when appropriate. It can be done through the education of investors. Or it can be done through price crashes. Price crashes are an incredibly inefficient means of doing the job because they cause massive unemployment and political unrest and business failures and broken marriages and a hundred other bad things. The far easier way to do this would be just to let investors know that valuations affect long-term returns and that everyone needs to consider this when setting his or her stock allocation.
The ONLY reason why a valuation component was not included in the first draft version of the Buy-and-Hold package is that the Efficient Market Theory was popular at the time and it wasn't understood how important the valuation component was to making the thing work in the long term. Now we know. So we should go back and make the necessary fix. All that Valuation-Informed Indexing is is Bogle's Buy-and-Hold with a valuation component added. But that makes a big difference. Buy-and-Hold is always going to cause massive economic collapses because it takes price discipline out of the market while VII would provide a means for middle-class people looking for a simple way to participate in the stock market to do so without doing any damage to the overall economy.
I believe that all of the "controversy" over these matters is political in nature. There is no economic argument today that valuations do not affect long-term returns (the Efficient Market Theory was discredited a long, long time ago). All of the economic suffering we are living through today is just because the Big Shots who came up with this idea cannot bear to acknowledge that they made a mistake in failing to include a valuation component in the package.
I don't say that to hurt anyone's feelings. I say it because I see this economic crisis as a serious thing and I think that people need to get serious about responding to it and so far I don't see too many people talking about the real problem. Stocks were overvalued by $12 trillion in 2000. We knew that money was going to disappear. Overvaluation always disappears. Even Bogle acknowledges this. So we knew in 2000 that we would be suffering an economic collapse sometime over the next 10 years. We should have dealt with the problem then.
Now that it is too late to deal with it then, we should deal with it now. We are all better off with a functioning economic and political system. It is amazing to me that such points even need to be argued.
Rob
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RobBennett
- Posts: 120
- Joined: Wed Aug 11, 2010 8:09 pm
- Contact:
"Another criticism I've heard is that the predictive qualities of statistics about extremely low PE10 values are limited, as the sample size is extremely small."
This is an important point. I am not fully qualified to address it as I am very much a words guy and not at all a numbers guy. However, I have heard lots of numbers guys talk about this question. So it might be that I can pass along some of their insights without messing up the description too much.
If people want to understand the statistical questions, I think the best place to start is Shiller's work. Here is a link to work he did that lays out the basics (It's called "Valuation Ratios and the Long-Run Stock Market Outlook -- An Update"):
http://cowles.econ.yale.edu/P/cd/d12b/d1295.pdf
Juicy Excerpt #1: On December 1996, we testified before the Federal Reserve Board that, despite all the evidence that stock returns are hard to forecast in the short run, this simple theory of mean reversion is basically right and does indeed imply a poor long-run stock market outlook.... Valuation ratios moved up in the year 2000 to levels that were absolutely unprecedented, and are still nearly as high as of this writing at the beginning of 2001. Even allowing for the possibility that the economy and financial markets have undergone some structural changes, these ratios imply a stronger case for a poor stock market outlook than has ever been seen before.
Juicy Excerpt #2: It is striking how well the evidence for stock market predictability survives the various corrections and adjustments that have been proposed in this research.
Juicy Excerpt #3: These valuation ratios deserve a special place among forecasting variables because we have such a long time series of data on these ratios, and because they relate stock prices to careful evaluations of the fundamental value of corporations. Earnings have been calculated and reported by U.S. corporations for over a hundred years for the express purpose of allowing us to judge intrinsic value. Dividend distribution decisions have been made by corporations for just as long with a sense that dividends should be set in such a way that they can reasonably be expected to continue.
Juicy Excerpt #4: Linear regressions of price changes and total returns on the log valuation ratios suggest substantial declines in real stock prices, and real stock returns below zero, over the next 10 years.
BUT PLEASE ALSO NOTE THE CAVEAT SHILLER ADDS:
Juicy Excerpt #5: The very fact that ratios have moved so far outside their historical range poses a challenge however, both to the traditional view that stock prices reflect rational expectations of future cash flows, and to our view that they are substantially driven by mean
reversion. Observers of either persuasion must face the fact that something extremely
unusual has occurred. In this situation a broad judgment of our position in history, of the
uniqueness of recent technological advances and investment patterns, and of the state of
market psychology assumes more than usual importance in judging the outlook for the
stock market. There is no purely statistical method to resolve finally whether the data
indicate that we have entered a new era, invalidating old relations, or whether we are still
in a regime where ratios will revert to old levels. In our personal judgment, while we do
not expect a complete return to traditional valuation levels, we still interpret the broad
variety of evidence as suggesting a poor long-term outlook for the stock market.
No one knows the definitive and final truth about stock investing. What we need is a NATIONAL DEBATE aimed at getting to the bottom of all this to the extent that is possible. To some extent we are just going to need to accept that there are going to be things we are not going to know for certain.
Buy-and-Hold is one model. I certainly do not say that we should silence the Buy-and-Holders. We need their contributions to make sense of things. What I say is that we need to stop pretending that the Buy-and-Hold Model is the only model available to us. Shiller's model is the OPPOSITE of the Buy-and-Hold Model and he is a respected figure in the field as are his many followers. It's time to stop pretending that the Buy-and-Holders settled all these questions once and for all. They put forward some ideas. Now some other people have put forward some different ideas. People need to be able to hear both sides and then decide for themselves. That's how these sorts of differences are handled in every other field of life endeavor.
Rob
This is an important point. I am not fully qualified to address it as I am very much a words guy and not at all a numbers guy. However, I have heard lots of numbers guys talk about this question. So it might be that I can pass along some of their insights without messing up the description too much.
If people want to understand the statistical questions, I think the best place to start is Shiller's work. Here is a link to work he did that lays out the basics (It's called "Valuation Ratios and the Long-Run Stock Market Outlook -- An Update"):
http://cowles.econ.yale.edu/P/cd/d12b/d1295.pdf
Juicy Excerpt #1: On December 1996, we testified before the Federal Reserve Board that, despite all the evidence that stock returns are hard to forecast in the short run, this simple theory of mean reversion is basically right and does indeed imply a poor long-run stock market outlook.... Valuation ratios moved up in the year 2000 to levels that were absolutely unprecedented, and are still nearly as high as of this writing at the beginning of 2001. Even allowing for the possibility that the economy and financial markets have undergone some structural changes, these ratios imply a stronger case for a poor stock market outlook than has ever been seen before.
Juicy Excerpt #2: It is striking how well the evidence for stock market predictability survives the various corrections and adjustments that have been proposed in this research.
Juicy Excerpt #3: These valuation ratios deserve a special place among forecasting variables because we have such a long time series of data on these ratios, and because they relate stock prices to careful evaluations of the fundamental value of corporations. Earnings have been calculated and reported by U.S. corporations for over a hundred years for the express purpose of allowing us to judge intrinsic value. Dividend distribution decisions have been made by corporations for just as long with a sense that dividends should be set in such a way that they can reasonably be expected to continue.
Juicy Excerpt #4: Linear regressions of price changes and total returns on the log valuation ratios suggest substantial declines in real stock prices, and real stock returns below zero, over the next 10 years.
BUT PLEASE ALSO NOTE THE CAVEAT SHILLER ADDS:
Juicy Excerpt #5: The very fact that ratios have moved so far outside their historical range poses a challenge however, both to the traditional view that stock prices reflect rational expectations of future cash flows, and to our view that they are substantially driven by mean
reversion. Observers of either persuasion must face the fact that something extremely
unusual has occurred. In this situation a broad judgment of our position in history, of the
uniqueness of recent technological advances and investment patterns, and of the state of
market psychology assumes more than usual importance in judging the outlook for the
stock market. There is no purely statistical method to resolve finally whether the data
indicate that we have entered a new era, invalidating old relations, or whether we are still
in a regime where ratios will revert to old levels. In our personal judgment, while we do
not expect a complete return to traditional valuation levels, we still interpret the broad
variety of evidence as suggesting a poor long-term outlook for the stock market.
No one knows the definitive and final truth about stock investing. What we need is a NATIONAL DEBATE aimed at getting to the bottom of all this to the extent that is possible. To some extent we are just going to need to accept that there are going to be things we are not going to know for certain.
Buy-and-Hold is one model. I certainly do not say that we should silence the Buy-and-Holders. We need their contributions to make sense of things. What I say is that we need to stop pretending that the Buy-and-Hold Model is the only model available to us. Shiller's model is the OPPOSITE of the Buy-and-Hold Model and he is a respected figure in the field as are his many followers. It's time to stop pretending that the Buy-and-Holders settled all these questions once and for all. They put forward some ideas. Now some other people have put forward some different ideas. People need to be able to hear both sides and then decide for themselves. That's how these sorts of differences are handled in every other field of life endeavor.
Rob