Jacob said something on the non-politics/politics thread that brought up a question that is of some importance to. If either he or anyone else is willing to share some thoughts, I would be grateful. Jacob has a background in science that I entirely lack. My guess is that there are a good number here who know more about science than I do (it would be hard to know less).
Jacob offered this list of distinctions:
fact - a data point, an observation, could be inaccurate, subject to precision
hypothesis - an explanation of a data point
law - a hypothesis that is consistently correct (predicts facts within precision)
theory - a collection of laws within a greater framework --- an abstraction of laws so to speak similar how to a law in an abstraction of facts.
He added:
To a scientist a "theory" is much stronger than a single "fact", because the theory is based on thousands [or simply a lot of] facts.
All of the work that I have done in the investing field runs counter to the tenets of the Buy-and-Hold Model, which is rooted in a belief in the Efficient Market Hypothesis/Theory (I have heard both terms used). It certainly would be fair to say that I am not a fan of the EMT as it has been put forward. However, I also believe that there is much merit in the thinking behind the EMT, that it comes CLOSE to being a huge breakthrough in our understanding of how stock investing works. I see it as a FLAWED theory or hypothesis or whatever.
Something that I run into all the time is that people just ASSUME that Buy-and-Hold must work because so many people have said that it does. I often try to explain that, no, it is really all just based on a theory/hypothesis that has been discredited (in my view!). One time I described the "theory" as "an idea that just passed through someone's head."
I was trying to indicate that there is no "evidence" (another term that needs to be defined) that supports the "theory." I believe this to be so. I think that there are people who THINK there is evidence but they have never carefully worked through the logic of all this and thus do not understand that the evidence can be used to support a very different "theory." There were some people who objected when I said that. They feel that this is more than a notion.
I want to be fair in my descriptions. I don't want to underplay the extent to which I believe the evidence has been misinterpreted. I believe that this misinterpretation has caused a great deal of misery. So I want to be firm on this point. But I also want to be fair. I don't want to be calling something a nation if it is really a hypothesis, or calling something an hypothesis if it is really a theory, or whatever.
My question is -- Is there anyone who can say what the true status of the Efficient Market idea is? I know that there are smart people who believe in it. I also know that there are smart people who completely dismiss it. Is it a true scientific theory? Or just an hypothesis? Or just a notion? Or a discredited theory? Or a theory hijacked for marketing purposes? Or what?
Any help that those who understand where the EMT fits in among these scientific terms can offer is much appreciated.
Rob
Is Efficient Market a Theory, Hypothesis, Fact, Law or Notion??
A hypothesis that holds true under certain conditions.
It has never been proven mathematically. And you probably could never prove EMT mathematically (for reasons I posted in the non-political section), the set of axioms/mathematical laws would never hold consistent.
You could try to prove EMT empirically and then say via scientific induction it will hold true forever more. But the past is a terrible way to predict the future, and definitely doesn't provide the needed proof to give something the title of "theorem".
So I therefor say "not a theorem" and a "hypothesis".
You could then try and argue that the hypothesis has been disproven. I'd say it has, but you could say it holds true under certain conditions (like if you watch the market > 40 years).
It has never been proven mathematically. And you probably could never prove EMT mathematically (for reasons I posted in the non-political section), the set of axioms/mathematical laws would never hold consistent.
You could try to prove EMT empirically and then say via scientific induction it will hold true forever more. But the past is a terrible way to predict the future, and definitely doesn't provide the needed proof to give something the title of "theorem".
So I therefor say "not a theorem" and a "hypothesis".
You could then try and argue that the hypothesis has been disproven. I'd say it has, but you could say it holds true under certain conditions (like if you watch the market > 40 years).
The efficient market idea is best described as a hypothesis. It simply does not has the same level of evidence and support to be a theory. However keep in mind to be classified as a theory you need an overwhelming amount of evidence including many making many predictions that could be falsified to prove the theory wrong but were not. That said, there is still a strong amount of evidence for the emh, but not nearly at the level of say the theory of evolution.
The way I view the emh is that it is a model that describes/predicts how some aspects of the market work. But to paraphrase the statistician Box, all models are wrong but some are useful. My reading of the evidence, as someone with analytical and statistical training (but not in finance) is that the markets are largely efficient and it is very difficult to get excess returns. However it's not perfectly efficient and there are outliers and anomalies but these can often be extremely difficult to take advantage of as an individual investor with tax and transactional costs.
My personal experience as an investor bears this out (this is anecdotal). How else could an investor who never even bothers to read financial statements do as well/better as buffet unless the markets were extremely efficient?
The way I view the emh is that it is a model that describes/predicts how some aspects of the market work. But to paraphrase the statistician Box, all models are wrong but some are useful. My reading of the evidence, as someone with analytical and statistical training (but not in finance) is that the markets are largely efficient and it is very difficult to get excess returns. However it's not perfectly efficient and there are outliers and anomalies but these can often be extremely difficult to take advantage of as an individual investor with tax and transactional costs.
My personal experience as an investor bears this out (this is anecdotal). How else could an investor who never even bothers to read financial statements do as well/better as buffet unless the markets were extremely efficient?
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RobBennett
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"A hypothesis that holds true under certain conditions."
Thanks for that, dpmorel. That's precisely what I was looking for.
"the past is a terrible way to predict the future, and definitely doesn't provide the needed proof to give something the title of "theorem"."
This makes sense to me.
I am a journalist, not a scientist or an academic or an investing expert. My sense is that what happened is that some academics came up with what you call "a hypothesis that holds true under certain conditions" and then some people in the financial field saw the marketing appeal in saying their ideas were backed by science and exaggerated the level of scientific support these ideas enjoy. If you or others feel that it is too controversial to confirm what I am saying here, I understand. If someone believes that I am jumping to unwarranted conclusions, I would be grateful if they would let me know.
My take is that we have seen a misuse of science. There really were academics who said these things. But their findings were tentative ones. The middle-class investor was worried about investing in stocks and the finance industry found that it provided a great deal of assurance to say that its ideas were backed by science. So they stretched the truth dramatically. The academics didn't object too loudly (if at all). And the whole thing over time got wildly out of control.
The tragic thing is that the middle-class investor was trying to be responsible. The average person doesn't know that much about investing or science. But he must invest his money! So he was vulnerable to claims that one particular approach was backed by science. The way that I said it in the title of a podcast is that "They Used Our Natural Risk Aversion Against Us."
They twisted things around to make a risky approach (staying at the same stock allocation even when prices are insanely high) SOUND like a safe, scientifically supported approach. They buried all mention of the holes in the idea and of the risks that would apply if the holes proved to be significant. My personal view is that this is a huge story. I find it amazing.
Your basic point here is so simple and yet so far-reaching. Anyone making claims of science in connection with investing strategies should be about 10 times more humble than just about everyone has been in recent decades. When you say that something is backed by science, there are people who will believe it. And there really is no way to offer "science" in support of an investing strategy in a truly legitimate way. All we have is historical data and that is not enough to claim absolute proof of anything.
"You could then try and argue that the hypothesis has been disproven. I'd say it has, but you could say it holds true under certain conditions (like if you watch the market > 40 years)."
Again, this sounds right to me.
But then we get back to this thing where investors have been led to believe something other than the realities. Investors are certainly not thinking that the "long term" is 40 years! They are thinking 5 years, maybe 10 years! And at those time-periods, things work the OPPOSITE of how they work in 40 years. So it seems to me that 90 percent of the investing advice of the past 30 years is rooted in word games!
Again, I just find this astounding. I had no idea that this sort of thing was going on when I first started investigating these matters. So I am confident that most middle-class investors have no idea how weak the scientific support is for the strategies they have been using to invest their retirement money. The implications here are just breathtaking. It seems to me that we could be looking at tens of thousands of lawsuits being filed in coming years as the losses resulting from all this grow larger and larger.
Anyway, I thank you for answering the question. I don't know if you agree with my editorial comments or not. But I think you are saying that I am not totally crazy in saying that the level of scientific support we are talking about here is less than strong. What are people thinking when they suggest otherwise?
When I first started writing about personal finance, I was scared to death that I would get something wrong and cause someone to suffer financial pain as a result of the mistake. It now seems to me that it is COMMON PRACTICE to urge high-risk strategies backed by claims of science that are not justified.
The only explanation that I can come up with for how people have gotten away with this for so long is that "everybody does it." But is that going to be enough if losses continue to mount? At some point will people start looking into this and see that the emperor is wearing no clothes? And how do we restore public faith in our economic and political institutions then? I go over this in my head again and again because I really have a hard time believing what very much appears to be the case.
Thanks for letting me vent a bit. If there are aspects of this where I am stating things wrong or missing nuances, I would certainly be grateful to have those weaknesses in my presentation pointed out to me. It is my intent to get it right, not just to have a big story. Actually, my experience is that the biggest obstacle to getting publicity for this story is that it is so huge that most people just cannot believe that it could possibly be true -- I would be better off if there were less here. That's a strange circumstance for a reporter too find himself in!
Rob
Thanks for that, dpmorel. That's precisely what I was looking for.
"the past is a terrible way to predict the future, and definitely doesn't provide the needed proof to give something the title of "theorem"."
This makes sense to me.
I am a journalist, not a scientist or an academic or an investing expert. My sense is that what happened is that some academics came up with what you call "a hypothesis that holds true under certain conditions" and then some people in the financial field saw the marketing appeal in saying their ideas were backed by science and exaggerated the level of scientific support these ideas enjoy. If you or others feel that it is too controversial to confirm what I am saying here, I understand. If someone believes that I am jumping to unwarranted conclusions, I would be grateful if they would let me know.
My take is that we have seen a misuse of science. There really were academics who said these things. But their findings were tentative ones. The middle-class investor was worried about investing in stocks and the finance industry found that it provided a great deal of assurance to say that its ideas were backed by science. So they stretched the truth dramatically. The academics didn't object too loudly (if at all). And the whole thing over time got wildly out of control.
The tragic thing is that the middle-class investor was trying to be responsible. The average person doesn't know that much about investing or science. But he must invest his money! So he was vulnerable to claims that one particular approach was backed by science. The way that I said it in the title of a podcast is that "They Used Our Natural Risk Aversion Against Us."
They twisted things around to make a risky approach (staying at the same stock allocation even when prices are insanely high) SOUND like a safe, scientifically supported approach. They buried all mention of the holes in the idea and of the risks that would apply if the holes proved to be significant. My personal view is that this is a huge story. I find it amazing.
Your basic point here is so simple and yet so far-reaching. Anyone making claims of science in connection with investing strategies should be about 10 times more humble than just about everyone has been in recent decades. When you say that something is backed by science, there are people who will believe it. And there really is no way to offer "science" in support of an investing strategy in a truly legitimate way. All we have is historical data and that is not enough to claim absolute proof of anything.
"You could then try and argue that the hypothesis has been disproven. I'd say it has, but you could say it holds true under certain conditions (like if you watch the market > 40 years)."
Again, this sounds right to me.
But then we get back to this thing where investors have been led to believe something other than the realities. Investors are certainly not thinking that the "long term" is 40 years! They are thinking 5 years, maybe 10 years! And at those time-periods, things work the OPPOSITE of how they work in 40 years. So it seems to me that 90 percent of the investing advice of the past 30 years is rooted in word games!
Again, I just find this astounding. I had no idea that this sort of thing was going on when I first started investigating these matters. So I am confident that most middle-class investors have no idea how weak the scientific support is for the strategies they have been using to invest their retirement money. The implications here are just breathtaking. It seems to me that we could be looking at tens of thousands of lawsuits being filed in coming years as the losses resulting from all this grow larger and larger.
Anyway, I thank you for answering the question. I don't know if you agree with my editorial comments or not. But I think you are saying that I am not totally crazy in saying that the level of scientific support we are talking about here is less than strong. What are people thinking when they suggest otherwise?
When I first started writing about personal finance, I was scared to death that I would get something wrong and cause someone to suffer financial pain as a result of the mistake. It now seems to me that it is COMMON PRACTICE to urge high-risk strategies backed by claims of science that are not justified.
The only explanation that I can come up with for how people have gotten away with this for so long is that "everybody does it." But is that going to be enough if losses continue to mount? At some point will people start looking into this and see that the emperor is wearing no clothes? And how do we restore public faith in our economic and political institutions then? I go over this in my head again and again because I really have a hard time believing what very much appears to be the case.
Thanks for letting me vent a bit. If there are aspects of this where I am stating things wrong or missing nuances, I would certainly be grateful to have those weaknesses in my presentation pointed out to me. It is my intent to get it right, not just to have a big story. Actually, my experience is that the biggest obstacle to getting publicity for this story is that it is so huge that most people just cannot believe that it could possibly be true -- I would be better off if there were less here. That's a strange circumstance for a reporter too find himself in!
Rob
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jacob
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Much as we like to think that we are a scientific culture, we aren't. We're a culture that believes in magic. Our magic may be science, but the way we believe in it is not scientific.
Ask a random person if they know the steps involved in the scientific method. If they actually get this right, ask them when was the last time they used it.
Ask a random person if they know the steps involved in the scientific method. If they actually get this right, ask them when was the last time they used it.
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RobBennett
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"My reading of the evidence, as someone with analytical and statistical training (but not in finance) is that the markets are largely efficient and it is very difficult to get excess returns. "
Thanks to you also, PhotoGuy. Your comments also sound perfectly sensible to me. The alarm that I express in my last post may not make sense to you given your take that the EMH is at least generally on the mark. So I'll try to offer a bit of an explanation of where I am coming from.
There are at least three ways to get excess returns: (1) to pick stocks effectively; (2) to engage in short-term timing (changing your allocation with the expectation that you will see a benefit within a year or so); and (3) to engage in long-term timing (changing your allocation in response to big valuation level changes with the understanding that you may not see a benefit for doing so for as long as 10 years).
I believe that it is possible to pick stocks effectively. I don't personally believe that short-term timing works, but I am not dogmatic on this point; I think it is possible that there are some people who study this stuff a lot who can pull this off. But I don't have any big concerns re the conventional advice on those two approaches to earning excess returns. I share your view that the conventional advice is close enough although probably not precisely correct.
The thing that I am alarmed about is the third way of earning excess returns -- lowering your stock allocation when prices go to insanely dangerous levels (long-term timing). I am not even able to IMAGINE a scenario in which long-term timing would not yield excess returns (at least on a risk-adjusted basis). And the implications here are huge re our economic crisis and re the future of stock investing analysis.
In the event that long-term timing works (the entire historical record shows that it does -- there is precisely zero evidence cutting the other way [although we need to keep in mind dpmorel's point that historical data can only justify tentative findings]), all investment advisors should have been telling their clients to lower their stock allocations in the late 1990s, when valuation levels went far higher than even those that caused the Great Depression. A regression analysis of the historical data shows that the most likely annualized 10-year return of a purchase of an index fund in 2000 was a negative 1 percent real. Those who start saving at age 25 and who plan to retire at age 65 have only four decades to save what they need and lost one of those four decades by following the conventional advice.
That has dire implications for our economy. The dollar value of the overvaluation in 2000 was $12 trillion. Reversion to the Mean (which even Bogle cites as an "Iron Law" of stock investing) told us that that $12 trillion of wealth was going to disappear from the economy sometime over the course of the next 10 or 15 years. There's your economic crisis! No economy can take a $12 trillion hit and not collapse.
So the entire economic crisis was optional. It was caused by the promotion of Buy-and-Hold Investing strategies, the idea that investors do not need to change their stock allocations in response to big price swings. This is what the EMH has done to us. I agree with you that there are elements of the EMH that are more or less right. But is there any truth whatsoever to the claim that it is okay (or even a good idea!) to stay at the same stock allocation when valuations rise to insanely dangerous levels? I have been working this six days a week for eight years now and I can tell you that I have never found a single sliver of data indicating that this particular EMH/Buy-and-Hold claim might be true.
It might be better to look at it from the other direction, the positive direction. We have had four economic crises in the United States from 1900 forward. Each and every one was preceded by a time at which the P/E10 level rose to 25 or higher. What if we told investors what very much appears to be the most important reality of stock investing, that investors MUST, MUST, MUST lower their stock allocations when the P/E10 level gets close to 25? Would that mean that we would never again experience an economic crisis?
It seems to me that there is at least a good chance that that is so. Or that it is at least so that we would experience fewer economic crises if we told investors the realities. In any event, it is impossible for me to see any downside to doing this and entirely possible for me to imagine all sorts of wonderful upside to doing it.
The retirement studies that financial planners use to help their clients plan retirements are rooted in the EMH/Buy-and-Hold mindset. That is, they contain no adjustment for the valuation level that applies on the day the retirement begins. If you look at the data, you see that it says that the single most important factor in determining retirement safety is the valuation level that applies on the day the retirements begins. There are never retirement failures starting from times of low or moderate valuations. All retirement failures start from times when we have the sorts of valuation levels that we had from 1996 through 2008.
The implications go much, much farther than just a total rewrite of all retirement planning guidance. If valuations tell us significant information re the long-term returns we will enjoy from stocks, stocks are not nearly as risky as people have long thought them to be. If Shiller is right that valuations matter, STOCKS ARE LESS RISKY THAN BONDS (for those investors willing to take valuations into consideration when setting their stock allocations).
Rob Arnott, former editor of the Financial Analysts Journal, says that we are standing on the threshold of a "revolution" in our understanding of how stock investing works. The benefits could be so great that they could bring on the greatest period of economic growth in our nation's history. The only thing holding us back today is institutional resistance from the "experts" who have advocated Buy-and-Hold for many years. And the only thing that the experts ever cite as their justification for blocking people from learning what very much appear to be the realities is that it would be "dangerous" for anyone to be permitted to question the "science" of Buy-and-Hold.
If it is really not science, and at least when it comes to this question of whether valuations affect long-term returns I am personally highly confident that it is not, we have caused an economic crisis by permitting these claims to remain uncontested for so long. And we are now holding back a period of economic growth that would be big enough to take us out of this crisis. For what? Why are we doing this to ourselves?
Because we cannot bear to let some people know that their "theory" is really just an hypothesis, and, when it comes to the long-term timing question, probably a whole big bunch less than that. My sense is that, when it comes to long-term timing, the whole thing is just a huge MISTAKE or a misguided marketing campaign. I get the strong sense that the EMH was never even intended to address this aspect of the question. So we are arguing with air. There is no science, there is no theory, there is no hypothesis, there is no nothing.
You probably can sense that this is a hobby horse of mine. I hope I have been able to get across some of the explanation for why I think it is so important.
It wasn't really my purpose with this thread to convince people (I am always glad when that happens, of course). I brought this up because of Jacob's description of the scientific levels of confidence. I don't know much about that aspect of things and I really do want to be sure that I say things properly (there are people who would love to be able to eat me alive if I ever failed to do so). My sense from what I am hearing is that I have been saying it more or less right.
YOU are right that there are aspects of the EMH that more or less make some sense. But there does not appear to be any evidence whatsoever that long-term timing does not work. Again, though, if I am wrong about that, I would prefer to find that out as soon as possible so that I can stop making a fool of myself re this matter.
Rob
Thanks to you also, PhotoGuy. Your comments also sound perfectly sensible to me. The alarm that I express in my last post may not make sense to you given your take that the EMH is at least generally on the mark. So I'll try to offer a bit of an explanation of where I am coming from.
There are at least three ways to get excess returns: (1) to pick stocks effectively; (2) to engage in short-term timing (changing your allocation with the expectation that you will see a benefit within a year or so); and (3) to engage in long-term timing (changing your allocation in response to big valuation level changes with the understanding that you may not see a benefit for doing so for as long as 10 years).
I believe that it is possible to pick stocks effectively. I don't personally believe that short-term timing works, but I am not dogmatic on this point; I think it is possible that there are some people who study this stuff a lot who can pull this off. But I don't have any big concerns re the conventional advice on those two approaches to earning excess returns. I share your view that the conventional advice is close enough although probably not precisely correct.
The thing that I am alarmed about is the third way of earning excess returns -- lowering your stock allocation when prices go to insanely dangerous levels (long-term timing). I am not even able to IMAGINE a scenario in which long-term timing would not yield excess returns (at least on a risk-adjusted basis). And the implications here are huge re our economic crisis and re the future of stock investing analysis.
In the event that long-term timing works (the entire historical record shows that it does -- there is precisely zero evidence cutting the other way [although we need to keep in mind dpmorel's point that historical data can only justify tentative findings]), all investment advisors should have been telling their clients to lower their stock allocations in the late 1990s, when valuation levels went far higher than even those that caused the Great Depression. A regression analysis of the historical data shows that the most likely annualized 10-year return of a purchase of an index fund in 2000 was a negative 1 percent real. Those who start saving at age 25 and who plan to retire at age 65 have only four decades to save what they need and lost one of those four decades by following the conventional advice.
That has dire implications for our economy. The dollar value of the overvaluation in 2000 was $12 trillion. Reversion to the Mean (which even Bogle cites as an "Iron Law" of stock investing) told us that that $12 trillion of wealth was going to disappear from the economy sometime over the course of the next 10 or 15 years. There's your economic crisis! No economy can take a $12 trillion hit and not collapse.
So the entire economic crisis was optional. It was caused by the promotion of Buy-and-Hold Investing strategies, the idea that investors do not need to change their stock allocations in response to big price swings. This is what the EMH has done to us. I agree with you that there are elements of the EMH that are more or less right. But is there any truth whatsoever to the claim that it is okay (or even a good idea!) to stay at the same stock allocation when valuations rise to insanely dangerous levels? I have been working this six days a week for eight years now and I can tell you that I have never found a single sliver of data indicating that this particular EMH/Buy-and-Hold claim might be true.
It might be better to look at it from the other direction, the positive direction. We have had four economic crises in the United States from 1900 forward. Each and every one was preceded by a time at which the P/E10 level rose to 25 or higher. What if we told investors what very much appears to be the most important reality of stock investing, that investors MUST, MUST, MUST lower their stock allocations when the P/E10 level gets close to 25? Would that mean that we would never again experience an economic crisis?
It seems to me that there is at least a good chance that that is so. Or that it is at least so that we would experience fewer economic crises if we told investors the realities. In any event, it is impossible for me to see any downside to doing this and entirely possible for me to imagine all sorts of wonderful upside to doing it.
The retirement studies that financial planners use to help their clients plan retirements are rooted in the EMH/Buy-and-Hold mindset. That is, they contain no adjustment for the valuation level that applies on the day the retirement begins. If you look at the data, you see that it says that the single most important factor in determining retirement safety is the valuation level that applies on the day the retirements begins. There are never retirement failures starting from times of low or moderate valuations. All retirement failures start from times when we have the sorts of valuation levels that we had from 1996 through 2008.
The implications go much, much farther than just a total rewrite of all retirement planning guidance. If valuations tell us significant information re the long-term returns we will enjoy from stocks, stocks are not nearly as risky as people have long thought them to be. If Shiller is right that valuations matter, STOCKS ARE LESS RISKY THAN BONDS (for those investors willing to take valuations into consideration when setting their stock allocations).
Rob Arnott, former editor of the Financial Analysts Journal, says that we are standing on the threshold of a "revolution" in our understanding of how stock investing works. The benefits could be so great that they could bring on the greatest period of economic growth in our nation's history. The only thing holding us back today is institutional resistance from the "experts" who have advocated Buy-and-Hold for many years. And the only thing that the experts ever cite as their justification for blocking people from learning what very much appear to be the realities is that it would be "dangerous" for anyone to be permitted to question the "science" of Buy-and-Hold.
If it is really not science, and at least when it comes to this question of whether valuations affect long-term returns I am personally highly confident that it is not, we have caused an economic crisis by permitting these claims to remain uncontested for so long. And we are now holding back a period of economic growth that would be big enough to take us out of this crisis. For what? Why are we doing this to ourselves?
Because we cannot bear to let some people know that their "theory" is really just an hypothesis, and, when it comes to the long-term timing question, probably a whole big bunch less than that. My sense is that, when it comes to long-term timing, the whole thing is just a huge MISTAKE or a misguided marketing campaign. I get the strong sense that the EMH was never even intended to address this aspect of the question. So we are arguing with air. There is no science, there is no theory, there is no hypothesis, there is no nothing.
You probably can sense that this is a hobby horse of mine. I hope I have been able to get across some of the explanation for why I think it is so important.
It wasn't really my purpose with this thread to convince people (I am always glad when that happens, of course). I brought this up because of Jacob's description of the scientific levels of confidence. I don't know much about that aspect of things and I really do want to be sure that I say things properly (there are people who would love to be able to eat me alive if I ever failed to do so). My sense from what I am hearing is that I have been saying it more or less right.
YOU are right that there are aspects of the EMH that more or less make some sense. But there does not appear to be any evidence whatsoever that long-term timing does not work. Again, though, if I am wrong about that, I would prefer to find that out as soon as possible so that I can stop making a fool of myself re this matter.
Rob
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RobBennett
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"Much as we like to think that we are a scientific culture, we aren't."
I am going to sound terribly pushy with this next comment, Jacob, but please feel 100 percent free to just say "no thanks" in response (I have had a good number of people say a lot ruder things to me many times in recent years so I am thick-skinned at this point).
You mentioned in one of your blog posts that, with the book finished, you may be looking for a new project. If you have any interest whatsoever in this one, I know that you could be a huge help. I obviously believe there is a huge potential to do good here. If you have never looked at the comments I have received from both regular people and from big-name experts in the field, I would be grateful if you would give a little thought to doing so. There are 80 of them at the "People Are Talking" section of my blog ("A Rich Life") [the comments are on the left-hand side of the page after you scroll down a bit]. The comments indicate that it is not just me who sees huge potential here.
You are of course right that we are not a scientific culture. An argument can be made that we have the worst of all worlds. Most people RESPECT scientific claims; most people let claims said to be rooted in science influence them. But, no, most of us (me very much included) do not have the knowledge to know when we are being taken by these claims.
I think Arnott is right. I think we are on the verge of a revolution in stock investing. This thing has just been building and building for 30 years and now things have gotten so out of hand that we are in the second worst economic crisis in our history. It wouldn't take much to turn the tide. And the implications reach in a hundred directions once that happens.
Again, I am just asking. I of course understand that all of us have lots of things on our plates and that there are many good reasons to take a pass. I feel obligated to ask when I see possible opportunities. That's the spirit in which I raise the possibility. Thanks for letting me run these ideas past some people here and to thereby gain some helpful feedback.
Rob
I am going to sound terribly pushy with this next comment, Jacob, but please feel 100 percent free to just say "no thanks" in response (I have had a good number of people say a lot ruder things to me many times in recent years so I am thick-skinned at this point).
You mentioned in one of your blog posts that, with the book finished, you may be looking for a new project. If you have any interest whatsoever in this one, I know that you could be a huge help. I obviously believe there is a huge potential to do good here. If you have never looked at the comments I have received from both regular people and from big-name experts in the field, I would be grateful if you would give a little thought to doing so. There are 80 of them at the "People Are Talking" section of my blog ("A Rich Life") [the comments are on the left-hand side of the page after you scroll down a bit]. The comments indicate that it is not just me who sees huge potential here.
You are of course right that we are not a scientific culture. An argument can be made that we have the worst of all worlds. Most people RESPECT scientific claims; most people let claims said to be rooted in science influence them. But, no, most of us (me very much included) do not have the knowledge to know when we are being taken by these claims.
I think Arnott is right. I think we are on the verge of a revolution in stock investing. This thing has just been building and building for 30 years and now things have gotten so out of hand that we are in the second worst economic crisis in our history. It wouldn't take much to turn the tide. And the implications reach in a hundred directions once that happens.
Again, I am just asking. I of course understand that all of us have lots of things on our plates and that there are many good reasons to take a pass. I feel obligated to ask when I see possible opportunities. That's the spirit in which I raise the possibility. Thanks for letting me run these ideas past some people here and to thereby gain some helpful feedback.
Rob
@ Rob Bennett
You, Jacob, and Shiller have unveiled some things for me on finance. I moved 1/2 my 401k into "safe" funds for long term timing (Although, I really enjoyed September after I sold near end of August:)). I don't feel bad though. I made the move entirely based off my reflection on risk tolerance.
It occurred to me that I was not willing to potentially lose half my wealth again to mumble "in the long term" after reviewing how history repeats itself. Especially now that I soon plan to ERE.
It may be possible to do better "in the long term" staying fully invested in the market but anyone living off their investments is better with less volatility unless extremely wealthy.
In hindsight, I think any ERE is better off keeping half their money in funds that maintain principle or have more consistent long term returns. That way they can take advantage of long term timing by having "cash" investments to move into the market at the times when it is good to buy.
I was fully invested, so I had no say in valuation prior to my move. All in the market may do better long term, but then what does an ERE do for the decades that don't provide?
You, Jacob, and Shiller have unveiled some things for me on finance. I moved 1/2 my 401k into "safe" funds for long term timing (Although, I really enjoyed September after I sold near end of August:)). I don't feel bad though. I made the move entirely based off my reflection on risk tolerance.
It occurred to me that I was not willing to potentially lose half my wealth again to mumble "in the long term" after reviewing how history repeats itself. Especially now that I soon plan to ERE.
It may be possible to do better "in the long term" staying fully invested in the market but anyone living off their investments is better with less volatility unless extremely wealthy.
In hindsight, I think any ERE is better off keeping half their money in funds that maintain principle or have more consistent long term returns. That way they can take advantage of long term timing by having "cash" investments to move into the market at the times when it is good to buy.
I was fully invested, so I had no say in valuation prior to my move. All in the market may do better long term, but then what does an ERE do for the decades that don't provide?
@RobB
I don't think that the EMH implies that bubbles cannot occur and that valuations can't get out of whack for certain asset classes.
I also don't think that the EMH implies that strict buy-and-hold is the best investment strategy. Certainly, if there have been changes to the underlying assets (like the valuations have changed and hence changed the statistically expected return / risk), I think most investors should take action and adjust their portfolio appropriately to maintain the level of risk they desire.
Finally regarding market timing, I have not seen any evidence that market timing can be done with a statistically positive expectation (but I haven't really looked at original research papers here). The thing to note from an investment perspective, is that even if you correctly identify the presence of bubble, the best strategy may not be to cash out because you may do so too early and miss much of the gains. In my view, the best thing may be to keep riding the bubble upwards and rebalancing to capture gains and limit risk.
I don't think that the EMH implies that bubbles cannot occur and that valuations can't get out of whack for certain asset classes.
I also don't think that the EMH implies that strict buy-and-hold is the best investment strategy. Certainly, if there have been changes to the underlying assets (like the valuations have changed and hence changed the statistically expected return / risk), I think most investors should take action and adjust their portfolio appropriately to maintain the level of risk they desire.
Finally regarding market timing, I have not seen any evidence that market timing can be done with a statistically positive expectation (but I haven't really looked at original research papers here). The thing to note from an investment perspective, is that even if you correctly identify the presence of bubble, the best strategy may not be to cash out because you may do so too early and miss much of the gains. In my view, the best thing may be to keep riding the bubble upwards and rebalancing to capture gains and limit risk.
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RobBennett
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"You, Jacob, and Shiller have unveiled some things for me on finance."
Thanks for those kind words, Dude. Please understand that everything I have learned I have learned through the same process you have used-- talking things over with my friends on boards and blogs. It's about taking when you need to take and giving back when you are able to give back. I have taken a great deal and I like to think that I have made some effort to give some back as well. In any event, this is a communications medium of huge potential.
"It may be possible to do better "in the long term" staying fully invested"
The historical record indicates that it is possible but an extreme long-shot, Dude. I have a calculator at my site called the Scenario Surfer that lets you choose a stock allocation based on stock valuations for each year of a 30-year returns sequence and then compare how you do with how those following a rebalancing strategy did. The return sequences are random sequences consistent with the sequences we have seen throughout the historical record.
I've run the calculator hundreds of times. Rebalancing does better in about 1 in 10 tries. That indicates to me that there is extreme risk in a rebalancing strategy. I'd rather go with the approach that works in 9 out of 10 scenarios. And there are cases in which the valuation-informed approach leaves you with a portfolio double the size of the one you would have obtained by rebalancing.
Here's the URL:
http://www.passionsaving.com/portfolio-allocation.html
Rob
Thanks for those kind words, Dude. Please understand that everything I have learned I have learned through the same process you have used-- talking things over with my friends on boards and blogs. It's about taking when you need to take and giving back when you are able to give back. I have taken a great deal and I like to think that I have made some effort to give some back as well. In any event, this is a communications medium of huge potential.
"It may be possible to do better "in the long term" staying fully invested"
The historical record indicates that it is possible but an extreme long-shot, Dude. I have a calculator at my site called the Scenario Surfer that lets you choose a stock allocation based on stock valuations for each year of a 30-year returns sequence and then compare how you do with how those following a rebalancing strategy did. The return sequences are random sequences consistent with the sequences we have seen throughout the historical record.
I've run the calculator hundreds of times. Rebalancing does better in about 1 in 10 tries. That indicates to me that there is extreme risk in a rebalancing strategy. I'd rather go with the approach that works in 9 out of 10 scenarios. And there are cases in which the valuation-informed approach leaves you with a portfolio double the size of the one you would have obtained by rebalancing.
Here's the URL:
http://www.passionsaving.com/portfolio-allocation.html
Rob
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RobBennett
- Posts: 120
- Joined: Wed Aug 11, 2010 8:09 pm
- Contact:
"I don't think that the EMH implies that bubbles cannot occur"
There are many smart and good believe who believe what you are saying here, Photoguy. I have to say that I do not get it even a tiny little bit. This is the disconnect that either I have or that others have. I don't at all mean to be offering any personal criticism in saying this. I just truly would like to understand what people mean when they say this.
Isn't an efficient market a properly priced market? Isn't the idea that investors collectively use all the information available to identify the proper price of the market better than any individual investor could? If an individual investor can do better by looking at valuations, that investor has an edge. It seems to me that if one investor can gain an edge just by looking at valuations, the market by definition is not efficient.
There were lots of people who predicted the crash. All the people who take valuations seriously did so. Shiller predicted it. And Arnott predicted it. And Easterling predicted it. And John Walter Russell predicted it. And Grantham predicted it. And Asness predicted it. And Smithers predicted it. The Buy-and-Holders did not predict it. Doesn't that tell us something?
What it tells me is that the model that the people who are not able to predict are using is a bad model and the model that the people who can predict are using is a good model. The difference between the two models is that one says that the price set by the market is always the best possible price that could be assigned and the other says that the price set by the market AND ADJUSTED FOR VALUATIONS is the best possible price that could be assigned but that the price not adjusted for valuations is in error. The very word "overvaluation" tells us that the market price is in error. Isn't the word "overvalued" really just another way of saying "mispriced"?
It's not my intent to be argumentative, Photoguy. As I say, you are in very good company with what you say here. It's good that you put up the comment because the thread lacks balance without it. People should be able to see that there are smart and good people who do not have confidence in what I am pushing. And it could really be that I just have a blind spot and that one day someone like you is going to say something like what you said and it is going to click for me. And it could be that you saying it will lay the groundwork for me being able to hear those words.
People have differences of opinion re these matters. That's for sure. In honesty, I have to say that i just do not get it. But in charity I also feel a need to say that I know that you are trying to help and I am grateful to you for going to the trouble. And maybe you are right and I am wrong. It's been known to happen!
Rob
There are many smart and good believe who believe what you are saying here, Photoguy. I have to say that I do not get it even a tiny little bit. This is the disconnect that either I have or that others have. I don't at all mean to be offering any personal criticism in saying this. I just truly would like to understand what people mean when they say this.
Isn't an efficient market a properly priced market? Isn't the idea that investors collectively use all the information available to identify the proper price of the market better than any individual investor could? If an individual investor can do better by looking at valuations, that investor has an edge. It seems to me that if one investor can gain an edge just by looking at valuations, the market by definition is not efficient.
There were lots of people who predicted the crash. All the people who take valuations seriously did so. Shiller predicted it. And Arnott predicted it. And Easterling predicted it. And John Walter Russell predicted it. And Grantham predicted it. And Asness predicted it. And Smithers predicted it. The Buy-and-Holders did not predict it. Doesn't that tell us something?
What it tells me is that the model that the people who are not able to predict are using is a bad model and the model that the people who can predict are using is a good model. The difference between the two models is that one says that the price set by the market is always the best possible price that could be assigned and the other says that the price set by the market AND ADJUSTED FOR VALUATIONS is the best possible price that could be assigned but that the price not adjusted for valuations is in error. The very word "overvaluation" tells us that the market price is in error. Isn't the word "overvalued" really just another way of saying "mispriced"?
It's not my intent to be argumentative, Photoguy. As I say, you are in very good company with what you say here. It's good that you put up the comment because the thread lacks balance without it. People should be able to see that there are smart and good people who do not have confidence in what I am pushing. And it could really be that I just have a blind spot and that one day someone like you is going to say something like what you said and it is going to click for me. And it could be that you saying it will lay the groundwork for me being able to hear those words.
People have differences of opinion re these matters. That's for sure. In honesty, I have to say that i just do not get it. But in charity I also feel a need to say that I know that you are trying to help and I am grateful to you for going to the trouble. And maybe you are right and I am wrong. It's been known to happen!
Rob
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RobBennett
- Posts: 120
- Joined: Wed Aug 11, 2010 8:09 pm
- Contact:
It's not my intent to press my point too hard here, Photoguy. But I just would like to compare two sentences you put forward because they do such a good job of getting to this heart of this.
The first sentence is a clear statement of everything I believe. I think it is a statement that most Buy-and-Holders would sign onto. And, if they did, there would seemingly be no controversy here. Because your first sentence in essence covers everything I have put forward. Anyone who believes in the first sentence is a Valuation-Informed Indexer (presuming that they invest in indexes), in my view.
But the second sentence refutes the first sentence, in my assessment.
Here's Sentence One:
"Certainly, if there have been changes to the underlying assets (like the valuations have changed and hence changed the statistically expected return / risk), I think most investors should take action and adjust their portfolio appropriately to maintain the level of risk they desire."
Here's Sentence Two:
"Finally regarding market timing, I have not seen any evidence that market timing can be done with a statistically positive expectation (but I haven't really looked at original research papers here). "
Isn't the first sentence recommending market timing? The investor would be changing his stock allocation at TIMEs at which valuations got too high. That's market timing.
I can point you to data showing that what you describe in the first sentence has always worked. But I am not sure that we even need to look at data. Doesn't it HAVE to work? Is the rational human mind capable of imagining a circumstance in which it would not work (at least on a risk-adjusted basis -- rebalancing DOES work in 1 out of 10 possible returns sequences, as noted above, we just haven't run into one in the historical record yet).
I can tell you that I was advocating this idea BEFORE I ever looked at any data. I am no statistics wiz, so I did not feel that I could study data without help. So I got started on this by going to a board and asking if anyone was willing to help me out. There were some Buy-and-Holders there who said "Oh, you really need to look at the data, it is going to show that you are wrong." My response was "Well, I would really like to see that data because that sounds impossible to me, I just don't see how data could show something that logically cannot happen." So we looked at the data. And we learned that the data shows that this has ALWAYS worked. There is not one exception in the historical record, going back to 1870 (that's as far back as we have data).
I am not telling this story to brag. I am trying to suggest what I believe might be the cause of all the confusion. There IS data indicating that short-term timing does not work. There's lots of data on that point. I believe that what is going on here is that people did studies showing that short-term timing does not work and they got all excited about their finding (which is indeed a big deal) and they jumped to the conclusion that long-term timing also does not work. But that does not actually follow. And it is an equally big deal to know that long-term timing always works if that is indeed the case.
Again, I am not seeking to be argumentative. I am trying to convey how unfortunate it is that people do not make more of an effort to try to understand each other's positions. I believe that we could all learn wonderful things if we could put our heads together on questions like this (as I mentioned above, I need lots of help with the statistical questions and with the science question and all that sort of thing).
I'll tell one more story to give a bit more of a sense of what I see as the tragedy of all this. There is a fellow named "Larry" who visited my site. He is a wonderful guy. I spent several hours talking on the phone to him as well as trading dozens of e-mails with him. He started off highly skeptical. Some of his comments were sort of snarky. But he is intellectually honest. He eventually said: "Here is what I will do, Rob. I will spend the next three weeks going over everything at your site and at John Walter Russell's site and then I will write up a paper either saying that you are right on or that you are full of it." I said that sounded great.
He came back to me and said that everything checked out. He was bubbling over with enthusiasm. He said that he had once worked with Ross Perot and that he thought that he could get Perot involved. He said that he thought he could get venture capital money behind this idea. He said that he was going to contact state pension-fund regulators. He said that he couldn't sleep because his mind was racing with all the exciting things we could do with this.
Then we got to a discussion of details. I used the phrase "long-term timing" and he said "well, we can't say that." He said that he could not imagine any state regulators or any other people of influence ever getting behind anything that involves market timing. He is a 100 percent sincere guy. I know this. And I also know that he is a 100 percent smart guy. He just cannot get over the hurdle that this wonderful thing we have discovered involves market timing.
Is it a bad thing that Shiller's research has taught us how to time the market successfully for the first time in history? I think it is a wonderful thing. I think it opens hundreds of doors. As I noted above, it means that stocks become far less risky than they have ever been before. Russell did an analysis to be able to say statistically how predictable long-term stock returns are. He found that, if you look at valuations before you buy, your 20-year return is 78 percent predictable. The unknown factor is only 22 percent. It is the unknown that is risk, right? So we have reduced the risk of investing in stocks by 78 percent! Could there be better news?
The rub is always that achieving all these wonderful things requires acknowledging that there is one form of market timing (long-term timing based on valuations) that always works. If we could just get over the hurdle of acknowledging that this surprising finding is GOOD NEWS, I really think we could overcome this economic crisis and retire years sooner and invest with less risk while obtaining higher returns. That's been the only rub going back to the first day.
I think we are in the circumstances we were in when the automobile was invented. The buggywhip industry hated the idea! But the benefits of cars were just so great that sooner or later the buggywhip industry was going to lose the fight. You cannot deny millions of people something so good for ever and ever. That's how good I think this is. And the only downside is that we need to acknowledge that we were wrong in thinking that market timing doesn't work. Some FORMS of market timing never work. But some forms ALWAYS work. We need to distinguish.
Anyway, that is where I am coming from. I have become an intensely controversial figure. But all that I am saying is contained in that first sentence of yours, Photoguy. That sums the entire thing up. All that I add is that I provide people with tools (like the Scenario Surfer) to do what you describe in that first sentence effectively. And your sentence is not viewed as being even a tiny bit controversial. The thing that starts the fire is that, when you provide tools to do what you describe effectively, it hits people that this shows that there is a form of timing that always works and then their heads explode.
That's my take re what is going on, in any event. Again, I am grateful for you being willing to share your thoughts, Photoguy, and I hope that I have not misrepresented your thoughts or talked your ear off in excess of what even the most patient person can bear. My excuse is that I love this stuff and see great potential in it and I want to get about the business of sharing it with every investor interested in learning about it. That's deep in me and I don't think that there's too much that can be done by me or anyone else to change that one. Springsteen would shout out at his concerts: "I'm a slave to rock and roll!" I would have to shout out: "I'm a slave to safe withdrawal rates!"
Rob
The first sentence is a clear statement of everything I believe. I think it is a statement that most Buy-and-Holders would sign onto. And, if they did, there would seemingly be no controversy here. Because your first sentence in essence covers everything I have put forward. Anyone who believes in the first sentence is a Valuation-Informed Indexer (presuming that they invest in indexes), in my view.
But the second sentence refutes the first sentence, in my assessment.
Here's Sentence One:
"Certainly, if there have been changes to the underlying assets (like the valuations have changed and hence changed the statistically expected return / risk), I think most investors should take action and adjust their portfolio appropriately to maintain the level of risk they desire."
Here's Sentence Two:
"Finally regarding market timing, I have not seen any evidence that market timing can be done with a statistically positive expectation (but I haven't really looked at original research papers here). "
Isn't the first sentence recommending market timing? The investor would be changing his stock allocation at TIMEs at which valuations got too high. That's market timing.
I can point you to data showing that what you describe in the first sentence has always worked. But I am not sure that we even need to look at data. Doesn't it HAVE to work? Is the rational human mind capable of imagining a circumstance in which it would not work (at least on a risk-adjusted basis -- rebalancing DOES work in 1 out of 10 possible returns sequences, as noted above, we just haven't run into one in the historical record yet).
I can tell you that I was advocating this idea BEFORE I ever looked at any data. I am no statistics wiz, so I did not feel that I could study data without help. So I got started on this by going to a board and asking if anyone was willing to help me out. There were some Buy-and-Holders there who said "Oh, you really need to look at the data, it is going to show that you are wrong." My response was "Well, I would really like to see that data because that sounds impossible to me, I just don't see how data could show something that logically cannot happen." So we looked at the data. And we learned that the data shows that this has ALWAYS worked. There is not one exception in the historical record, going back to 1870 (that's as far back as we have data).
I am not telling this story to brag. I am trying to suggest what I believe might be the cause of all the confusion. There IS data indicating that short-term timing does not work. There's lots of data on that point. I believe that what is going on here is that people did studies showing that short-term timing does not work and they got all excited about their finding (which is indeed a big deal) and they jumped to the conclusion that long-term timing also does not work. But that does not actually follow. And it is an equally big deal to know that long-term timing always works if that is indeed the case.
Again, I am not seeking to be argumentative. I am trying to convey how unfortunate it is that people do not make more of an effort to try to understand each other's positions. I believe that we could all learn wonderful things if we could put our heads together on questions like this (as I mentioned above, I need lots of help with the statistical questions and with the science question and all that sort of thing).
I'll tell one more story to give a bit more of a sense of what I see as the tragedy of all this. There is a fellow named "Larry" who visited my site. He is a wonderful guy. I spent several hours talking on the phone to him as well as trading dozens of e-mails with him. He started off highly skeptical. Some of his comments were sort of snarky. But he is intellectually honest. He eventually said: "Here is what I will do, Rob. I will spend the next three weeks going over everything at your site and at John Walter Russell's site and then I will write up a paper either saying that you are right on or that you are full of it." I said that sounded great.
He came back to me and said that everything checked out. He was bubbling over with enthusiasm. He said that he had once worked with Ross Perot and that he thought that he could get Perot involved. He said that he thought he could get venture capital money behind this idea. He said that he was going to contact state pension-fund regulators. He said that he couldn't sleep because his mind was racing with all the exciting things we could do with this.
Then we got to a discussion of details. I used the phrase "long-term timing" and he said "well, we can't say that." He said that he could not imagine any state regulators or any other people of influence ever getting behind anything that involves market timing. He is a 100 percent sincere guy. I know this. And I also know that he is a 100 percent smart guy. He just cannot get over the hurdle that this wonderful thing we have discovered involves market timing.
Is it a bad thing that Shiller's research has taught us how to time the market successfully for the first time in history? I think it is a wonderful thing. I think it opens hundreds of doors. As I noted above, it means that stocks become far less risky than they have ever been before. Russell did an analysis to be able to say statistically how predictable long-term stock returns are. He found that, if you look at valuations before you buy, your 20-year return is 78 percent predictable. The unknown factor is only 22 percent. It is the unknown that is risk, right? So we have reduced the risk of investing in stocks by 78 percent! Could there be better news?
The rub is always that achieving all these wonderful things requires acknowledging that there is one form of market timing (long-term timing based on valuations) that always works. If we could just get over the hurdle of acknowledging that this surprising finding is GOOD NEWS, I really think we could overcome this economic crisis and retire years sooner and invest with less risk while obtaining higher returns. That's been the only rub going back to the first day.
I think we are in the circumstances we were in when the automobile was invented. The buggywhip industry hated the idea! But the benefits of cars were just so great that sooner or later the buggywhip industry was going to lose the fight. You cannot deny millions of people something so good for ever and ever. That's how good I think this is. And the only downside is that we need to acknowledge that we were wrong in thinking that market timing doesn't work. Some FORMS of market timing never work. But some forms ALWAYS work. We need to distinguish.
Anyway, that is where I am coming from. I have become an intensely controversial figure. But all that I am saying is contained in that first sentence of yours, Photoguy. That sums the entire thing up. All that I add is that I provide people with tools (like the Scenario Surfer) to do what you describe in that first sentence effectively. And your sentence is not viewed as being even a tiny bit controversial. The thing that starts the fire is that, when you provide tools to do what you describe effectively, it hits people that this shows that there is a form of timing that always works and then their heads explode.
That's my take re what is going on, in any event. Again, I am grateful for you being willing to share your thoughts, Photoguy, and I hope that I have not misrepresented your thoughts or talked your ear off in excess of what even the most patient person can bear. My excuse is that I love this stuff and see great potential in it and I want to get about the business of sharing it with every investor interested in learning about it. That's deep in me and I don't think that there's too much that can be done by me or anyone else to change that one. Springsteen would shout out at his concerts: "I'm a slave to rock and roll!" I would have to shout out: "I'm a slave to safe withdrawal rates!"
Rob
@RobB
-- I enjoy the discussion otherwise I wouldn't be here. So please do probe as hard as you want. I've also discovered that pointed questioning helps me understand my own ideas a little better and help point errors in my own thoughts.
I'm not an expert at the EMH, but from what I understand of it, efficiency refers to the transmission of information and not necessarily accuracy of the price. For example, if a company unexpectedly misses their earnings target you may see an instantaneous price adjustment. However, I don't believe that the EMH implies that the price of the stock, after incorporating all the new information, is perfect. Rather I think it means that it has been weighed and incorporated somehow into the stock's price. I.e., the market has used the information to make it's best guess as to the price, but it is only a guess which in hindsight may turn out to be wrong.
Regarding the sentence: "Certainly, if there have been changes to the underlying assets (like the valuations have changed and hence changed the statistically expected return / risk), I think most investors should take action and adjust their portfolio appropriately to maintain the level of risk they desire."
Here's an example of what I mean: say that my asset allocation is 15% to large-caps and they then experience a large amount of appreciation and as a whole went from p/e 15 to p/e 30. Given that the p/e multiple doubled, it's probably also true that large-caps would be a much greater percentage of my portfolio, say 25%. In my view this would have increased my risk because my portfolio is less diversified I would rebalance by selling large-caps until I was back to my 15% plan.
Regarding Shiller's research, predicting the crash, and selling when valuations get too high. It's not just a matter of predicting that a crash will occur but also picking the best time to leave the market. For example, my dad has been predicing that the US market was well overpriced and predicted a crash since 96. However, if an investor were to follow his advice, they would have missed a ton of appreciation from 96-2001 which would more than have offset the decrease in 2001. So while I do believe it's possible to understand that valuations are probably higher than they should be -- I'm not sure it's possible to consistently time the market and get out before the crash with a higher average return (I haven't seen any direct studies on market timing -- most of the literature I've seen examines active investor who may employ market timing but probably mainly focus on stock selection).
-- I enjoy the discussion otherwise I wouldn't be here. So please do probe as hard as you want. I've also discovered that pointed questioning helps me understand my own ideas a little better and help point errors in my own thoughts.
I'm not an expert at the EMH, but from what I understand of it, efficiency refers to the transmission of information and not necessarily accuracy of the price. For example, if a company unexpectedly misses their earnings target you may see an instantaneous price adjustment. However, I don't believe that the EMH implies that the price of the stock, after incorporating all the new information, is perfect. Rather I think it means that it has been weighed and incorporated somehow into the stock's price. I.e., the market has used the information to make it's best guess as to the price, but it is only a guess which in hindsight may turn out to be wrong.
Regarding the sentence: "Certainly, if there have been changes to the underlying assets (like the valuations have changed and hence changed the statistically expected return / risk), I think most investors should take action and adjust their portfolio appropriately to maintain the level of risk they desire."
Here's an example of what I mean: say that my asset allocation is 15% to large-caps and they then experience a large amount of appreciation and as a whole went from p/e 15 to p/e 30. Given that the p/e multiple doubled, it's probably also true that large-caps would be a much greater percentage of my portfolio, say 25%. In my view this would have increased my risk because my portfolio is less diversified I would rebalance by selling large-caps until I was back to my 15% plan.
Regarding Shiller's research, predicting the crash, and selling when valuations get too high. It's not just a matter of predicting that a crash will occur but also picking the best time to leave the market. For example, my dad has been predicing that the US market was well overpriced and predicted a crash since 96. However, if an investor were to follow his advice, they would have missed a ton of appreciation from 96-2001 which would more than have offset the decrease in 2001. So while I do believe it's possible to understand that valuations are probably higher than they should be -- I'm not sure it's possible to consistently time the market and get out before the crash with a higher average return (I haven't seen any direct studies on market timing -- most of the literature I've seen examines active investor who may employ market timing but probably mainly focus on stock selection).
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RobBennett
- Posts: 120
- Joined: Wed Aug 11, 2010 8:09 pm
- Contact:
"I'm not an expert at the EMH, but from what I understand of it, efficiency refers to the transmission of information and not necessarily accuracy of the price. "
Based on everything I've ever heard, you are describing it exactly right, Photoguy. What the theory says is that all information is reflected in the price.
But isn't that really the same thing as saying that it is the best possible price that could be arrived at at the time? Any price that did NOT include all available information would be inferior to the price that DID include all available information, right? So the efficient price is also the best price. They're not saying it is perfect. They're saying it is the best possible.
Now --
If the market price is the best possible price, it certainly follows that you cannot time the market. If the market is setting the best possible price, no individual investor can gain an edge. So forget about beating the market. This is Buy-and-Hold. It logically follows from the Efficient Market premise. I give them that. I just don't think the premise holds.
If the market is always giving us the best possible price, there is no such thing as overvaluation. It is a pure nonsense concept, is it not? A price cannot be both the best possible price AND an overvalued price at the same time, can it? If we believe in the efficient market, we cannot believe that overvaluation is a meaningful concept. If we believe that overvaluation is a meaningful concept, we cannot believe that the market is efficient. The two ideas are in direct conflict.
Shiller did research in 1981 showing that valuations PREDICT long-term returns. This cannot be if overvaluation is a meaningless concept. Most of us are trying to avoid facing this conflict. We are living in a twilight zone in which we view the market as being kinda sorta efficient and in which we also believe that valuations kinda sorta matter. I believe that we need to confront this conflict and resolve it. I believe that knowing which path is the right one opens the door to all sorts of powerful insights.
Set forth below is the URL for a graphic prepared by Norbert Schenkler, a financial planner and part-owner of a financial forum. Norbert banned me from his forum. He believes that my investing ideas are "dangerous." But he played it straight when preparing this graphic comparing Buy-and-Hold and Valuation-Informed Indexing over the historical record. He says: "The evidence is pretty incontrovertible. Valuation-Informed Indexing...is everywhere superior to Buy-and-Hold over ten-year periods." He notes one exception in his comments -- the late 1990s -- but that exception no longer applies since the 2008 crash (he prepared the graphic prior to the crash).
http://www.financialwebring.org/forum/v ... p?t=106998
Could this be a coincidence? Could it be that the entire historical record shows that valuations affect long-term returns but that really they do not? The odds of that have to be extremely long. I think that what is going on here is that valuations really DO affect long-term returns. There's a MOUNTAIN of research showing this today.
Why doesn't everyone know it then? Everyone does kinda sorta know it. No one flat-out denies that valuations affect long-term returns. But people are very, very, very reluctant to explore the implications. Saying that valuations affect long-term returns is the same thing as saying that valuations PREDICT (at least to some extent) long-term returns. To say that returns can be predicted to a significant extent is to say that market timing works. People do not want to go there.
I am saying that we need to go there. If market timing really does always work, then the market is not efficient. If the market is not efficient, 90 percent of the investing advice that has been put out over the past 30 years is wrong. Most retirement planning advice is wrong. Most asset allocation advice is wrong. Most risk management advice is wrong. Just about everything you see is premised on the Efficient Market Theory. If that is wrong (and we are not talking about a small error here, if valuations matter the EMT numbers are WILDLY wrong), everything is wrong.
If 90 percent of the investment advice of the past 30 years is wildly wrong, wouldn't that explain an economic crisis? Huge amounts of wealth are tied up in the stock market. If it is all being dramatically mismanaged, wouldn't that pretty much destroy the free market all by itself? We don't need to worry so much about mortgages and bank regulation and derivatives and all this stuff.
The encouraging part of the story is that this one would be so easy to fix. We don't need to pass any law. All we need to do is to permit people to hear the realities. I have seen huge interest in this at every board and blog at which I have participated. Thousands of people have expressed a desire to learn more. That translates into millions in the general population. If we let this out, it is going to go viral in no time. The only thing holding it back is that the Buy-and-Holders feel that it would be "dangerous" to let people hear about these ideas.
This brings us full circle to the original point of the thread. Is that science? I say "no." I say that science is a quest for truth; you follow the evidence wherever it happens to lead. If the evidence tells you that market timing always works and in fact is REQUIRED for long-term success, that's what you go with. I love the idea of applying science to investing (to the extent that it is possible to do so). But I think that part of the scientific process is being open-minded to learning about mistakes and to fixing them. I think that a mistake was made in the early days and that it got us off track and that we need to pull things back, we need to question some of the premises of our thinking in this area.
Rob
Based on everything I've ever heard, you are describing it exactly right, Photoguy. What the theory says is that all information is reflected in the price.
But isn't that really the same thing as saying that it is the best possible price that could be arrived at at the time? Any price that did NOT include all available information would be inferior to the price that DID include all available information, right? So the efficient price is also the best price. They're not saying it is perfect. They're saying it is the best possible.
Now --
If the market price is the best possible price, it certainly follows that you cannot time the market. If the market is setting the best possible price, no individual investor can gain an edge. So forget about beating the market. This is Buy-and-Hold. It logically follows from the Efficient Market premise. I give them that. I just don't think the premise holds.
If the market is always giving us the best possible price, there is no such thing as overvaluation. It is a pure nonsense concept, is it not? A price cannot be both the best possible price AND an overvalued price at the same time, can it? If we believe in the efficient market, we cannot believe that overvaluation is a meaningful concept. If we believe that overvaluation is a meaningful concept, we cannot believe that the market is efficient. The two ideas are in direct conflict.
Shiller did research in 1981 showing that valuations PREDICT long-term returns. This cannot be if overvaluation is a meaningless concept. Most of us are trying to avoid facing this conflict. We are living in a twilight zone in which we view the market as being kinda sorta efficient and in which we also believe that valuations kinda sorta matter. I believe that we need to confront this conflict and resolve it. I believe that knowing which path is the right one opens the door to all sorts of powerful insights.
Set forth below is the URL for a graphic prepared by Norbert Schenkler, a financial planner and part-owner of a financial forum. Norbert banned me from his forum. He believes that my investing ideas are "dangerous." But he played it straight when preparing this graphic comparing Buy-and-Hold and Valuation-Informed Indexing over the historical record. He says: "The evidence is pretty incontrovertible. Valuation-Informed Indexing...is everywhere superior to Buy-and-Hold over ten-year periods." He notes one exception in his comments -- the late 1990s -- but that exception no longer applies since the 2008 crash (he prepared the graphic prior to the crash).
http://www.financialwebring.org/forum/v ... p?t=106998
Could this be a coincidence? Could it be that the entire historical record shows that valuations affect long-term returns but that really they do not? The odds of that have to be extremely long. I think that what is going on here is that valuations really DO affect long-term returns. There's a MOUNTAIN of research showing this today.
Why doesn't everyone know it then? Everyone does kinda sorta know it. No one flat-out denies that valuations affect long-term returns. But people are very, very, very reluctant to explore the implications. Saying that valuations affect long-term returns is the same thing as saying that valuations PREDICT (at least to some extent) long-term returns. To say that returns can be predicted to a significant extent is to say that market timing works. People do not want to go there.
I am saying that we need to go there. If market timing really does always work, then the market is not efficient. If the market is not efficient, 90 percent of the investing advice that has been put out over the past 30 years is wrong. Most retirement planning advice is wrong. Most asset allocation advice is wrong. Most risk management advice is wrong. Just about everything you see is premised on the Efficient Market Theory. If that is wrong (and we are not talking about a small error here, if valuations matter the EMT numbers are WILDLY wrong), everything is wrong.
If 90 percent of the investment advice of the past 30 years is wildly wrong, wouldn't that explain an economic crisis? Huge amounts of wealth are tied up in the stock market. If it is all being dramatically mismanaged, wouldn't that pretty much destroy the free market all by itself? We don't need to worry so much about mortgages and bank regulation and derivatives and all this stuff.
The encouraging part of the story is that this one would be so easy to fix. We don't need to pass any law. All we need to do is to permit people to hear the realities. I have seen huge interest in this at every board and blog at which I have participated. Thousands of people have expressed a desire to learn more. That translates into millions in the general population. If we let this out, it is going to go viral in no time. The only thing holding it back is that the Buy-and-Holders feel that it would be "dangerous" to let people hear about these ideas.
This brings us full circle to the original point of the thread. Is that science? I say "no." I say that science is a quest for truth; you follow the evidence wherever it happens to lead. If the evidence tells you that market timing always works and in fact is REQUIRED for long-term success, that's what you go with. I love the idea of applying science to investing (to the extent that it is possible to do so). But I think that part of the scientific process is being open-minded to learning about mistakes and to fixing them. I think that a mistake was made in the early days and that it got us off track and that we need to pull things back, we need to question some of the premises of our thinking in this area.
Rob
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RobBennett
- Posts: 120
- Joined: Wed Aug 11, 2010 8:09 pm
- Contact:
"I would rebalance by selling large-caps until I was back to my 15% plan."
Okay. That really is different from what I am saying, PhotoGuy. You are describing the Buy-and-Hold position.
Buy-and-Holders believe in rebalancing, which means selling when prices are high. This is a small step in the direction of Valuation-Informed Indexing. But I would argue that it does not go nearly far enough.
You come up with a stock allocation that you think is right for you. Then, when market prices change so that you are no longer at that allocation, you sell stocks to get back to that allocation. You are keeping your stock allocation constant FOR THE PURPOSE OF KEEPING YOUR RISK LEVEL CONSTANT.
I say that it is impossible to keep your risk level constant unless you are willing to CHANGE your stock allocation in response to valuation changes. I am saying that the same stock allocation carries dramatically different levels of risk at different valuation levels.
A 90 percent stock allocation is virtually risk-free when the P/E10 level is 7. Why? Because that's the lowest that stock valuations have ever gone. If valuations go up, you will make huge amounts of money. If they stay the same, you will earn the average long-term return of 6.5 percent real (you don't need any increase in valuations to earn the return that comes from profits of the underlying companies). Valuations CANNOT drop much further (at least they never have). So you are set.
A 30 percent stock allocation carries a great deal of risk when the P/E10 level is 44 (where it was in 2000). The P/E10 level always moves in the direction of fair value; this is Reversion to the Mean (an "Iron Law" of investing, according to Bogle). If valuations return to fair value (a P/E10 of 14), you will lose two-thirds of your money. If they fall to one-half of fair value (this is what has happened in every case in the historical record once prices rose to insane levels -- the reason is that the inevitable fall to fair value causes such a huge loss of wealth that it craters the entire economy), you lose 5/6ths of your money. There are no good long-term outcomes here.
If risk varies according to the valuation level, investors seeking to hold their risk level constant MUST change their stock allocations in response to big changes in valuations. There's no other way for them to achieve their goal. I agree strongly with Bogle's admonition to "Stay the Course." Where we differ is that he says to stay at the same stock allocation and I say to stay at the same risk level (which requires CHANGING your stock allocation).
I say that you cannot have it both ways: You cannot say that you want to Stay the Course and that you also want to practice Buy-and-Hold. Practicing Buy-and-Hold renders Staying the Course a logical impossibility.
It all goes back to that root premise. If the market is efficient, stocks are equally risky at all times (because overvaluation is a logical impossibility). If overvaluation is a meaningful concept, Buy-and-Hold cannot work.
Rahiv Sethie, an Economic Professor at Columbia University, described well what I am doing. He said: "Rob Bennett makes the claim that market timing based on aggregate P/E ratios can be a far more effective strategy than passive investing over long horizons (ten years or more). I am not in a position to evaluate this claim empirically but it is consistent with Shiller's analysis and I can see how it could be true."
The Shiller model for understanding how stock investing works is rooted in premises that are the OPPOSITE of the premises used in the Fama/Malkiel/Bogle model. What I have done is to take Shiller's ideas and show people how to implement them with their investment strategies (Shiller is an academic and rarely discusses implementation questions -- so this project has just been sitting out there waiting for someone to take it up for years now).
Buy-and-Holders have a hard time relating to what I say because we are essentially talking different languages. But it cannot be said that the new model is "unscientific". It is rooted in data every bit as much as the Fama model is. The differences are differences in INTERPRETATION of the data.
Rob
Okay. That really is different from what I am saying, PhotoGuy. You are describing the Buy-and-Hold position.
Buy-and-Holders believe in rebalancing, which means selling when prices are high. This is a small step in the direction of Valuation-Informed Indexing. But I would argue that it does not go nearly far enough.
You come up with a stock allocation that you think is right for you. Then, when market prices change so that you are no longer at that allocation, you sell stocks to get back to that allocation. You are keeping your stock allocation constant FOR THE PURPOSE OF KEEPING YOUR RISK LEVEL CONSTANT.
I say that it is impossible to keep your risk level constant unless you are willing to CHANGE your stock allocation in response to valuation changes. I am saying that the same stock allocation carries dramatically different levels of risk at different valuation levels.
A 90 percent stock allocation is virtually risk-free when the P/E10 level is 7. Why? Because that's the lowest that stock valuations have ever gone. If valuations go up, you will make huge amounts of money. If they stay the same, you will earn the average long-term return of 6.5 percent real (you don't need any increase in valuations to earn the return that comes from profits of the underlying companies). Valuations CANNOT drop much further (at least they never have). So you are set.
A 30 percent stock allocation carries a great deal of risk when the P/E10 level is 44 (where it was in 2000). The P/E10 level always moves in the direction of fair value; this is Reversion to the Mean (an "Iron Law" of investing, according to Bogle). If valuations return to fair value (a P/E10 of 14), you will lose two-thirds of your money. If they fall to one-half of fair value (this is what has happened in every case in the historical record once prices rose to insane levels -- the reason is that the inevitable fall to fair value causes such a huge loss of wealth that it craters the entire economy), you lose 5/6ths of your money. There are no good long-term outcomes here.
If risk varies according to the valuation level, investors seeking to hold their risk level constant MUST change their stock allocations in response to big changes in valuations. There's no other way for them to achieve their goal. I agree strongly with Bogle's admonition to "Stay the Course." Where we differ is that he says to stay at the same stock allocation and I say to stay at the same risk level (which requires CHANGING your stock allocation).
I say that you cannot have it both ways: You cannot say that you want to Stay the Course and that you also want to practice Buy-and-Hold. Practicing Buy-and-Hold renders Staying the Course a logical impossibility.
It all goes back to that root premise. If the market is efficient, stocks are equally risky at all times (because overvaluation is a logical impossibility). If overvaluation is a meaningful concept, Buy-and-Hold cannot work.
Rahiv Sethie, an Economic Professor at Columbia University, described well what I am doing. He said: "Rob Bennett makes the claim that market timing based on aggregate P/E ratios can be a far more effective strategy than passive investing over long horizons (ten years or more). I am not in a position to evaluate this claim empirically but it is consistent with Shiller's analysis and I can see how it could be true."
The Shiller model for understanding how stock investing works is rooted in premises that are the OPPOSITE of the premises used in the Fama/Malkiel/Bogle model. What I have done is to take Shiller's ideas and show people how to implement them with their investment strategies (Shiller is an academic and rarely discusses implementation questions -- so this project has just been sitting out there waiting for someone to take it up for years now).
Buy-and-Holders have a hard time relating to what I say because we are essentially talking different languages. But it cannot be said that the new model is "unscientific". It is rooted in data every bit as much as the Fama model is. The differences are differences in INTERPRETATION of the data.
Rob
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RobBennett
- Posts: 120
- Joined: Wed Aug 11, 2010 8:09 pm
- Contact:
"I.e., the market has used the information to make it's best guess as to the price"
I'll tell you what I think Fama missed.
Fama is right that the market SHOULD price stocks properly. His hypothesis makes all the logical sense in the world.
What he missed is that stocks are owned by humans and we cannot properly describe human behavior using only logic. Humans are guided in part by logic and also in part by emotion. The emotion part of all this is reflected in the valuation level. You need to ADJUST the nominal price set by the market by the amount of overvaluation to get the true market price.
I've mentioned that I have been banned at many boards and blogs. I am not the only one. Shiller is a tenured professor at Yale with a bestselling book to his credit. Yet he has said in interviews that he has never yet felt comfortable sharing all that he knows about stock investing. He said that, if he did this, he would be viewed as "unprofessional." I have had several bloggers tell me that they would like to run my Guest Blog Entries but that they are afraid of what Buy-and-Holders would do to their sites if they did so. I have had people send me e-mails telling me that they agree with my investing views but that they have learned that it is better to keep their mouths shut about what they know.
What does all this mean? It means that, for so long as stock valuations remain high, it is a literal impossibility for investors to hear the realities of stock investing discussed ANYWHERE. You could have some small niche board that discussed the realities. But not any large board or newspaper or radio show or whatever. Why? Because if the realities became known, investors would know that it is in their best interests to lower their stock allocations when prices are high and this would cause them to sell. The sales would bring prices back to reasonable levels!
Overvaluation and open discussion of the investing realities cannot coexist. We can have one or the other. Allow honest posting and overvaluation becomes an impossibility. To maintain overvaluation, you have to ban honest posting.
Fama is PRESUMING that the stock market works in the way that the market for consumer goods operates. When you buy a car, you are able to do research to determine the proper price. Then, if the dealer asks you to pay three times fair value, you run away. With stocks, it's not like that. With stocks, you would have to dig long and hard to learn the things I have learned (I have been doing this full-time for eight years now). So, when the stock price is set at three time fair value, most investors shrug and go ahead and pay the wildly inflated price. They delay their retirements by many years by doing so.
The market COULD be efficient. But to make it efficient, we need to be willing to permit investors to become informed about the effects of valuations on long-term return. Once we do that, there is no reason to believe that the market will ever become inefficient again. No one wants to invest ineffectively. The problem today is that few of us have been exposed to the information we need to see to become effective investors and we are not too excited about looking at it because we are emotionally invested in the strategies that once upon a time really did appear to be good ones.
The economic crisis is gradually changing that. But we are not there yet. Once we open things up, though, I believe that we will see this economy take off like a rocket. That's presuming that we don't put ourselves in the Second Great Depression first! Depressions can take a long time to recover from because they do so much damage to the infrastructure of the economic and political systems of the nations experiencing them.
Rob
I'll tell you what I think Fama missed.
Fama is right that the market SHOULD price stocks properly. His hypothesis makes all the logical sense in the world.
What he missed is that stocks are owned by humans and we cannot properly describe human behavior using only logic. Humans are guided in part by logic and also in part by emotion. The emotion part of all this is reflected in the valuation level. You need to ADJUST the nominal price set by the market by the amount of overvaluation to get the true market price.
I've mentioned that I have been banned at many boards and blogs. I am not the only one. Shiller is a tenured professor at Yale with a bestselling book to his credit. Yet he has said in interviews that he has never yet felt comfortable sharing all that he knows about stock investing. He said that, if he did this, he would be viewed as "unprofessional." I have had several bloggers tell me that they would like to run my Guest Blog Entries but that they are afraid of what Buy-and-Holders would do to their sites if they did so. I have had people send me e-mails telling me that they agree with my investing views but that they have learned that it is better to keep their mouths shut about what they know.
What does all this mean? It means that, for so long as stock valuations remain high, it is a literal impossibility for investors to hear the realities of stock investing discussed ANYWHERE. You could have some small niche board that discussed the realities. But not any large board or newspaper or radio show or whatever. Why? Because if the realities became known, investors would know that it is in their best interests to lower their stock allocations when prices are high and this would cause them to sell. The sales would bring prices back to reasonable levels!
Overvaluation and open discussion of the investing realities cannot coexist. We can have one or the other. Allow honest posting and overvaluation becomes an impossibility. To maintain overvaluation, you have to ban honest posting.
Fama is PRESUMING that the stock market works in the way that the market for consumer goods operates. When you buy a car, you are able to do research to determine the proper price. Then, if the dealer asks you to pay three times fair value, you run away. With stocks, it's not like that. With stocks, you would have to dig long and hard to learn the things I have learned (I have been doing this full-time for eight years now). So, when the stock price is set at three time fair value, most investors shrug and go ahead and pay the wildly inflated price. They delay their retirements by many years by doing so.
The market COULD be efficient. But to make it efficient, we need to be willing to permit investors to become informed about the effects of valuations on long-term return. Once we do that, there is no reason to believe that the market will ever become inefficient again. No one wants to invest ineffectively. The problem today is that few of us have been exposed to the information we need to see to become effective investors and we are not too excited about looking at it because we are emotionally invested in the strategies that once upon a time really did appear to be good ones.
The economic crisis is gradually changing that. But we are not there yet. Once we open things up, though, I believe that we will see this economy take off like a rocket. That's presuming that we don't put ourselves in the Second Great Depression first! Depressions can take a long time to recover from because they do so much damage to the infrastructure of the economic and political systems of the nations experiencing them.
Rob
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RobBennett
- Posts: 120
- Joined: Wed Aug 11, 2010 8:09 pm
- Contact:
"For example, my dad has been predicing that the US market was well overpriced and predicted a crash since 96. "
Your dad is one smart dude, in my opinion. I went to a zero stock allocation in the Summer of 1996, Photoguy. My money has been in TIPS and IBonds paying 3.5 percent real. If you do the math, that puts me ahead of where I would have been had I been invested in a broad index fund. And I will go further ahead after the next crash (when we destroy our economy with a huge bull market, we always end up at about one-half fair value, which is a 60 percent price drop from where we are today).
It's not so that you need to pick perfect exit or entry points when you engage in long-term timing. Stocks were priced insanely high for the entire time-period from January 1996 through September 2008. If you got out in 1996, you saw a benefit. But it was also okay to get out in 1997. Or 1998. Or 1999. Or 2000. Or 2001. And so on. Anytime in that 13-year time-period worked.
It will work the same way getting back in. After the next crash, stocks will be priced to provide amazing long-term returns. But you won't need to rush to get back in to enjoy those returns. There will probably be at least five years in which you will be able to get in at good prices and perhaps 10 year or more. Look at what happened the last time we went through this cycle. Stocks were well-priced in 1975. They remained at least reasonably well-priced all the way through 1995. Buying stocks at any time during that 20-year time-period paid off.
People get tripped up by focusing on short-term results. They see that someone got out in 1996 and they say "well, you missed the gains of 1997, 1998, and 1999" That's by design! Stocks were an insanely risky bet during those years. Yes, those were cases where the wild bets paid off. But wild bets cannot pay off forever and there is no way to know in advance what sort of year it is going to be. The only thing to do (in my view!) is to put money in when the odds are in your favor and to take money out when the odds are against you. It is the valuation level at which stocks are selling that determines the probabilities, according to the Shiller model.
Rob
Your dad is one smart dude, in my opinion. I went to a zero stock allocation in the Summer of 1996, Photoguy. My money has been in TIPS and IBonds paying 3.5 percent real. If you do the math, that puts me ahead of where I would have been had I been invested in a broad index fund. And I will go further ahead after the next crash (when we destroy our economy with a huge bull market, we always end up at about one-half fair value, which is a 60 percent price drop from where we are today).
It's not so that you need to pick perfect exit or entry points when you engage in long-term timing. Stocks were priced insanely high for the entire time-period from January 1996 through September 2008. If you got out in 1996, you saw a benefit. But it was also okay to get out in 1997. Or 1998. Or 1999. Or 2000. Or 2001. And so on. Anytime in that 13-year time-period worked.
It will work the same way getting back in. After the next crash, stocks will be priced to provide amazing long-term returns. But you won't need to rush to get back in to enjoy those returns. There will probably be at least five years in which you will be able to get in at good prices and perhaps 10 year or more. Look at what happened the last time we went through this cycle. Stocks were well-priced in 1975. They remained at least reasonably well-priced all the way through 1995. Buying stocks at any time during that 20-year time-period paid off.
People get tripped up by focusing on short-term results. They see that someone got out in 1996 and they say "well, you missed the gains of 1997, 1998, and 1999" That's by design! Stocks were an insanely risky bet during those years. Yes, those were cases where the wild bets paid off. But wild bets cannot pay off forever and there is no way to know in advance what sort of year it is going to be. The only thing to do (in my view!) is to put money in when the odds are in your favor and to take money out when the odds are against you. It is the valuation level at which stocks are selling that determines the probabilities, according to the Shiller model.
Rob
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Robert Muir
- Posts: 280
- Joined: Thu Jul 22, 2010 10:15 pm
Personally, I think the existence of bubbles, especially the ginormous tech bubble of '96-'00 and the recent housing bubble, basically proves the failure of an efficient market.
That said, I would rather gamble on solid value stocks and solid dividend paying stocks than to sit out the market until the market as a whole drops down to historically "fair" valuations.
If you don't put your money in equities, the question would be where to put it? Bonds have nowhere to go but down from here.
That said, I would rather gamble on solid value stocks and solid dividend paying stocks than to sit out the market until the market as a whole drops down to historically "fair" valuations.
If you don't put your money in equities, the question would be where to put it? Bonds have nowhere to go but down from here.
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RobBennett
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- Joined: Wed Aug 11, 2010 8:09 pm
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"I would rather gamble on solid value stocks and solid dividend paying stocks than to sit out the market until the market as a whole drops down to historically "fair" valuations."
I don't want to jump in on every comment. But I just want to be clear here that it is my view that it is entirely possible that picking stocks effectively could work even at times of overvaluation. There are always some stocks doing well.
The danger is for indexers. An indexer earns the market return -- by definition. If the market is extremely overvalued, the market as a whole is all but certain to provide a poor long-term return. So I think that indexers need to consider valuations when setting their stock allocations.
"If you don't put your money in equities, the question would be where to put it? Bonds have nowhere to go but down from here."
Again, just for the record, I am not fan of bonds either. I put my money in super-safe asset classes (TIPS, IBonds, CDs) when stocks offer a poor long-term value proposition. That way I have more money available to put in stocks when stock prices return to reasonable price levels.
I do NOT say that Valuation-Informed Indexing can beat effective stock picking. I say that it always beats conventional indexing on a risk-adjusted basis. Effective stock picking can beat all indexing strategies, in my view. But most middle-class investors are not willing to do the research required to be successful stock pickers. So I view indexing as the better choice for most investors.
Rob
I don't want to jump in on every comment. But I just want to be clear here that it is my view that it is entirely possible that picking stocks effectively could work even at times of overvaluation. There are always some stocks doing well.
The danger is for indexers. An indexer earns the market return -- by definition. If the market is extremely overvalued, the market as a whole is all but certain to provide a poor long-term return. So I think that indexers need to consider valuations when setting their stock allocations.
"If you don't put your money in equities, the question would be where to put it? Bonds have nowhere to go but down from here."
Again, just for the record, I am not fan of bonds either. I put my money in super-safe asset classes (TIPS, IBonds, CDs) when stocks offer a poor long-term value proposition. That way I have more money available to put in stocks when stock prices return to reasonable price levels.
I do NOT say that Valuation-Informed Indexing can beat effective stock picking. I say that it always beats conventional indexing on a risk-adjusted basis. Effective stock picking can beat all indexing strategies, in my view. But most middle-class investors are not willing to do the research required to be successful stock pickers. So I view indexing as the better choice for most investors.
Rob