The Shift to Valuation-Informed Indexing Is an All-or-Nothing Thing

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The Shift from Buy-and-Hold to Valuation-Informed Indexing is an all-or-nothing thing.


There is something in my personality that is drawn to compromise. When I hear about dilemmas that people face, my first reaction is to wonder whether there is some half-a-loaf solution that can be pursued. There usually is. Compromise is the most common means of resolving conflicts between opposed human wills.

For a long, long time, I have imagined that there would be a compromise worked out between the Buy-and-Holders and those of us who believe that Shiller’s Nobel-prize-winning research is legitimate research. It doesn’t take 21 years to determine whether a retirement study posted at some fellow’s web site contains a valuation adjustment. Why can’t the Buy-and-Holders just acknowledge that? Then we could all live in peace. Then we could all move on.

How Stock Investing Works

It’s the “move on” part that is the problem. I think that the Buy-and-Holders would be willing to acknowledge the error in the Greaney retirement study if it could stop there. It cannot stop there. The error that the people who developed Buy-and-Hold made was fundamental. The Buy-and-Hold way of thinking about how stock investing works and the Valuation-Informed Indexing way of thinking about how stock investing works are entirely at odds. Not just on the safe withdrawal rate issue. On every issue that comes up.

It took a long time for me to accept this. But there is no compromise possible. Either you believe that the market is efficient or you believe that valuations affect long-term returns. There is no middle ground. And of course there is no evidence that the market is efficient. The people who came up with the idea that the market is efficient are not silly people but that particular idea turned out to be a silly one. 100 percent of the evidence points in one direction and 0 percent of the evidence points in the other direction.

Assumption Of Valuation-Informed Indexing

The Buy-and-Holders understand that, if they concede an inch, it won’t be long before they find themselves conceding the entire football field. The only way for Buy-and-Hold to survive is for discussion of the research to be suppressed. The ban on honest posting is insane. But viewed from the perspective of someone whose livelihood depends on the survival of Buy-and-Hold, it makes a twisted sort of tactical sense.

The easiest way to understand this is to consider the emotional reaction you have to a price increase that takes place on a day when the CAPE is above 17. Buy-and-Hold posits that everything that happens in the stock market is rational. The only rational reason for prices to increase is as a response to positive economic developments. So the Buy-and-Hold reaction is to cheer the advance. Valuation-Informed Indexing posits that investing decisions are made by humans and humans are emotional creatures and price gains that are supported by nothing more than irrational exuberance cause huge amounts of human misery down the line. So the Valuation-Informed Indexing reaction is to bemoan the price increase.

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What is the compromise position between those two world views? It doesn’t exist. A price increase cannot be both a blessed event and the cause of great human misery at the same time. Either investors are 100 percent rational or they are human. It cannot be both.

Compromise becomes possible when we move past the core point of dispute. How often should investors engage in market timing? How much should a stock allocation be changed in response to a specified change in the CAPE value? How great is the potential penalty if an investor lowers his stock allocation based on the historical return data and prices remain high for a longer time than they ever have in the past (as has happened in recent years)? Those are important questions and those are questions that were made taboo in the Buy-and-Hold Era because they only make sense in a world in which investors are humans and not 100 percent rational. We will learn a great deal by exploring those sorts of questions in the days and years ahead.

But I no longer believe that compromise is possible re the core dispute. We cannot have one group of investment experts telling people that it is perfectly fine to stick with the same stock allocation when prices rise to the insane levels that we have seen apply in recent years. Once investors have easy access to accurate, honest, research-based reports, the Buy-and-Hold story is no longer credible. It is just too extreme.

There can be reasonable differences of opinion as to whether an investor should lower his stock allocation by 20 percent or 30 percent or 40 percent. There can be no reasonable case advanced that no allocation changes are needed no matter how high prices rise. That is dangerous dogma and, once the internet has been opened to honest posting re the research, investors are going to see that it is dangerous dogma. Either Buy-and-Hold will die or our economic and political systems will die because of our collective unwillingness to permit it to die.

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