Buy-and-Hold Is Dead — These Studies Prove It!

Buy-and-hold is dead. The Stock-Selling Industry has made millions promoting it. But buy-and-hold investing cannot survive the wealth of academic research showing that long-term timing always works.

The Stock-Selling Industry has long promoted the dangerous idea that it is okay for investors to stick to a single stock allocation at all price levels by pointing to academic research showing that short-term timing (changing your stock allocation with the expectation of seeing a benefit for doing so within six months or a year) never works. However, the same historical data that shows that short-term timing never works also shows that long-term timing (changing your stock allocation in response to big price swings with the understanding that doing so may not yield benefits for five years or even as long as ten years) always works. Thus, it is every bit as accurate a statement to say that “timing always works” as it is to say that “timing never works.” Which statement holds depends on what form of timing it is that you are employing.

Buy-and-Hold Is DeadSet forth below (this article was posted in November 2009) are links to 20 stock valuation studies either showing directly that long-term timing works or showing that valuations affect long-term returns and thereby suggesting that long-term timing must work (if valuations affect long-term returns, it obviously does not make sense to go with the same stock allocation at dramatically different valuation levels).

Study #1 Showing That Buy-and-Hold is Dead – Valuation Ratios and the Long-Run Stock Market Outlook:, by John Y. Campbell and Robert J. Shiller

Juicy Excerpt #1: On December 1996, we testified before the Federal Reserve Board that, despite all the evidence that stock returns are hard to forecast in the short run, this simple theory of mean reversion is basically right and does indeed imply a poor long-run stock market outlook…. Valuation ratios moved up in the year 2000 to levels that were absolutely unprecedented, and are still nearly as high as of this writing at the beginning of 2001. Even allowing for the possibility that the economy and financial markets have undergone some structural changes, these ratios imply a stronger case for a poor stock market outlook than has ever been seen before.

Juicy Excerpt #2: It is striking how well the evidence for stock market predictability survives the various corrections and adjustments that have been proposed in this research.

Juicy Excerpt #3: These valuation ratios deserve a special place among forecasting variables because we have such a long time series of data on these ratios, and because they relate stock prices to careful evaluations of the fundamental value of corporations. Earnings have been calculated and reported by U.S. corporations for over a hundred years for the express purpose of allowing us to judge intrinsic value. Dividend distribution decisions have been made by corporations for just as long with a sense that dividends should be set in such a way that they can reasonably be expected to continue.

Juicy Excerpt #4: Linear regressions of price changes and total returns on the log valuation ratios suggest substantial declines in real stock prices, and real stock returns below zero, over the next 10 years.

Study #2 Showing That Buy-and-Hold Is Dead – A Note on the Growing Evidence of Aggregate Stock Market Return Predictability,J.Bradford Delong

Juicy Excerpt #1: A generation ago it was possible to maintain the position that the way to bet was that movements in the aggregate stock market primarily reflected revisions to the rational expectations of future cash flows rather than bubbles or changes in the risk tolerance of the market. Today it is much less possible to dismiss the evidence that in the stock market what goes up comes down and what goes down comes up.

Juicy Excerpt #2: It has been nearly 30 years since economists began writing papers about…return predictability of the aggregate American stock market. They documented the evidence that when the price of the aggregate stock market went up or down relative to the anchor provided by dividends or earnings the way to bet was that the price movement would be reversed in the long run: that high stock prices (relative to current dividends or earnings) meant low future real stock returns and low stock prices (relative to current dividends or earnings) meant high future real stock returns.

Juicy Excerpt #3: It was possible to argue that these results were “junk science”: that a diligent search over different specifications had come up with one in which sampling error had created the illusion of a statistically significant relationship when in fact no such relationship existed.

Juicy Excerpt #4: Now we have nearly 30 years more of data…. The amount of return predictability that the regressions uncovers remains large…. If the evidence of return predictability presented a generation ago was “junk science,” the addition of the last 30 years of data to the previous 80-year sample should have led to an erosion of both the statistical and economic significance of long-run return predictability. The key distinguishing feature of “junk science” is that it does not work out of sample, and that as the sample is extended beyond the one over which the specification search was originally constructed the statistical significance and substantive importance of the results drops off very quickly. They have not.

Study #3 Showing That Buy-and-Hold Is Dead – May 2004 Overview — Safe Withdrawal Rate Research Group, John Walter Russell [The link to this post is no longer available. The link provided instead goes to an article at Russell's web site explaining the strong theoretical foundations of his SWR research.

Juicy Excerpt #1: There are many factors that affect the safety of withdrawals during retirement. Prices are one of them and prices are special. You control the prices that you pay for your investments.

Juicy Excerpt #2: Our first major milestone was met on June 24, 2003, when I submitted my post "Safe Withdrawal Rate Versus P/E10 Data." From a technical standpoint that post ended the Great Debate. It is meaningful to talk about Price-Adjusted Safe Withdrawal Rates and to estimate them using objective, mathematical techniques.

Study #4 Showing That Buy-and-Hold Is Dead -- What Risk Premium Is Normal?, Robert D. Arnott and Peter L. Bernstein

Rob ArnottJuicy Excerpt #1: Few have acknowledged that an important part of the lofty real returns of the past stemmed from rising valuation levels and from high dividend yields, which have long since diminished. As we will demonstrate, the long-term forward-looking risk premium is nowhere near the level of the past. Today, it may well be near zero, perhaps even negative.

Juicy Excerpt #2: If these kinds of projections were taken seriously, markets would be at far different levels from where they are.

Juicy Excerpt #3 The consensus that a normal risk premium is about 5 percent was shaped by deeply rooted naivete in the investment community, where most participants have a career span reaching no further back than the monumental 25-year bull market of 1975-1999.

Study #5 Showing That Buy-and-Hold Is Dead -- Bubble Logic,Clifford Asness

Juicy Excerpt #1: Although Wall Street research is made to look like independent science, and the financial media is made to look like neutral journalism, they are biased towards keeping you buying or holding common stocks.

Juicy Excerpt #2: Equities historically always returned a reasonable amount (or even a superb amount) over the long-term. One reason is that they were almost always priced reasonably. To assume that this long-term consistency will now exist independent of price is simply to believe in voodoo.

Juicy Excerpt #3 At today's prices, the world has it backward thinking that stocks are only safe if held for the long-term. If my analysis is correct, then a short-term investor may still do well (or poorly) as nobody knows what will happen in the short-term. However, if my analysis is correct, a long-term investor is in big trouble with a high probability, because in the long-term, irrational valuation loses.

Juicy Excerpt #4: Achieving a 6.8 percent compound real growth rate going forward would match the best post-war 20-year period ever, and come very close to the best 20-year period in about 125 years. However, when starting from such a high base as today, the best 20-year real S&P 500 compound earnings growth rate for over 125 years has been only 2.7 percent per annum.... Matching the best growth in history, a feat never close to attained when starting from good times, only gets you to mediocre long-term returns.

Juicy Excerpt #5: Wall Street is in the business of selling you stocks, and they do not want you leaving the market. Let us phrase the advice "do not try and time the market" another way. How about "ignore the price of what I am selling you and buy no matter what"? If you think about it, it is the same advice. If your salesman told you to ignore the price of any other purchase than common stocks because "it will all work out over the very long-run," you would run clutching your wallet.

Juicy Excerpt #6: If being price sensitive means timing the market, and timing the market is a cardinal sin, then prices have no anchor to reality. If one is looking for possible causes of a financial bubble, then the “ban” on market timing must be a prime candidate.

Juicy Excerpt #7: What do I think about market timing? Well, first, it is generally a bad idea because it is very hard to forecast short-term market movements, and transaction costs and taxes will kill you. Second, I think it is very important to distinguish the short-term from the long-term.... Over longer term horizons, I do think making conscious portfolio shifts based on the relative attractiveness of different asset classes can make sense, and especially so when extremes are reached.... Over the longer term, it seems pretty clear that either (a) the risk-premium on stocks has permanently come way down, or (b) people are in for a very rude awakening when they realize they do not like holding stocks with very low expected returns, and prices will then sharply fall.... It looks [these words were written in August 2000) like a pretty good bet to lighten up on equities now (this does not mean sell them all or go short). That is long-term market timing, and I think done occasionally in moderation it can make sense.

Juicy Excerpt #8: Imagine for a moment that somehow you privately knew for certain that the real return of the stock market would be negative over the next 20 years. What would you do now? Well, if you run a mutual fund you might very well stay fully invested. Imagine you sell stocks and raise a significant amount of cash and the bubble expands still further (obviously a very real possibility over short horizons, even if you know the next 20 year will be poor for stocks). When this happens, the marketplace has been quick to punish the under-invested fund manager. However, imagine you do not raise cash and the market declines sharply. Well, you are in the pack, and while your industry might suffer, you will not necessarily suffer relatively (and we all seem to care at least as much about relative as absolute suffering).

Juicy Excerpt #9: It seems very possible that we are all just doing a "dance macabre," gentlemen and fiduciaries all, waiting for the disaster we know is coming to strike, so we can all go down together.

Juicy Excerpt #10: Of course the only bright spot is that the inability of many to act on long-term knowledge, even if relatively certain, only increases the long-term benefit to those who can act.

Juicy Excerpt #11: It is very important to recognize that Wall Street is not an independent source of academic research, rather they are a manufacturer with a huge vested interest in supporting their product. I also think it must be recognized that a host of financial media are also much better off in an ongoing bull market, and perhaps act with a slant towards perpetrating this state.

Juicy Excerpt #12: It is far easier to focus on a bevy of distracting and ultimately irrelevant short-term phenomena (e.g., the Fed is stopping!, earning this quarter are great!), rather than the math. However, the short-term matters little, and the long-term is too important a thing to be left to bubble logic.

Study #6 Showing That Buy-and-Hold Is Dead -- Financial Physics,Ed Easterling

Juicy Excerpt #1: Conventional Wisdom and Long-Term Studies Often Ignore the Fundamental Factors That Drive Intermediate Stock Market Cycles

Ed Easterling

Juicy Excerpt #2: By multiplying the future price-earnings ratio for the S&P 500 stock index and the future earnings-per-share for the S&P 500, the level of the stock market as measured by the S&P 500 stock index can be determined.

Juicy Excerpt #3: Eight secular periods driven by the inflation and P/E cycle have occurred over the past century; each secular cycle has one or more shorter-term cyclical cycles. Investment strategies are significantly different for secular bull and secular bear markets.

Study #7 Showing That Buy-and-Hold Is Dead -- Stock Cycles, Michael Alexander (Described by John Mauldin at This Link)

Juicy Excerpt #1: Alexander's work shows that using past stock market cycles to predict the performance of the stock market one year from now is pretty much a random chance. Statistically, from almost any starting point, you have about a 50/50 chance of the market going up or down, using price movements alone to make your prediction. But there are certain long-term cycles which are not random and the probabilities of those repeating are very high.

Juicy Excerpt #2: Alexander provides, at least for me, the missing link between the patterns in stock cycles and the underlying economic fundamentals. I now see a logical connection between the position of the stars and the season. Alexander does not contend these cycles are as precisely predictable as the Spring Equinox. Rather, he suggests that when the underlying fundamental conditions occur, we can look for Spring-like conditions. Just as you plant certain types of plants in Spring and certain types in Winter, there are some investments which do better in their respective parts of the stock cycle. Carrying the analogy further, it is easier to grow your portfolio in economic Spring than in economic Winter. You have a much wider variety of "plants" from which to choose in Spring. You can plant Spring crops during the Winter, but you're going to have to wait until Spring to see them come up. It can be a long cold Winter in the meantime.

Juicy Excerpt #3: Simply based on this statistical model, Alexander concludes that there is a 75 percent change of a negative capital gains return for index-fund investors over the next 20 years. However, returns in any one year period are essentially random.

Juicy Excerpt #4: Earnings, we are told, are what drive the price of a stock. But earnings growth for the period 1965-1982 was roughly the same as for 1982-1999. Yet we all know that the S&P 500 had significantly different results. The first period was one of no stock price growth, and the latter saw growth of over 1,000 percent. What was the difference? Clearly, it was how investors perceived the relative value of the earnings. In a period of high inflation, earnings growth of 6-7 percent is not all that impressive. In today's low inflation environment, it is.

Juicy Excerpt #5: [This excerpt is from Alexander's book] If stock returns are truly random, then we should expect periods of above and below average performance to appear randomly, like flipping a coin…. Let’s consider one-month stock index returns as coin flips. We label an above-average return as a “head” and a below-average return as a “tail.” If stock returns are truly random we should expect that the number of above-average returns over this fifty month period to fall into a binomial distribution centered on 25, just as do the number of heads from fifty coin flips…. The correspondence is pretty good…. But what about longer periods?

What we can do is determine whether the returns from successive non-overlapping periods are above or below average. This is equivalent to carrying out a series of coin flips and noting the sequence of heads and tails obtained. The sequence is then examined for signs of non-randomness. For example, if we flipped eight coins in sequence and got the result HTHTHTHT, THTHTHTH, TTHHTTHH, or HHTTHHTT, we would be surprised. Strictly alternating periods like these are unlikely. The probability of any of these patterns arising from eight random coin flips is 1 in 64. A similar pattern in stock returns from sequential periods would also suggest non-randomness.

Peter Bernstein

Stock returns were calculated over sequential periods 9 to 20 years in length. For each return in sequence it was determined whether it was above (heads) or below (tails) the median value…. What we would like to know is whether any of the patterns are sufficiently “special” that its appearance would likely not be the result of chance…. The thirteen-year returns show 12 strictly alternating good and bad returns. The probability of such a pattern appearing in any of the entries in Table 2.1 is only 3.9 percent, strongly suggesting that the pattern exhibited by the thirteen-year period is non-random. The shortest repeating sequence in the special pattern for the thirteen-year case was two periods long, or 26 years, implying a 26-year cycle might be operating in stock returns. Here we see evidence of non-random behavior on a multi-decade time scale.

Study #8 Showing That Buy-and-Hold Is Dead – How to Compute the Real Value of the Stock Market, General Dynamics Site

Juicy Excerpt #1: We have three methods, producing these results: Dow 4618, 5268, and 4500. These numbers represent the approximate “real value” of the stock market today…. These methods are all quite reasonable and the only reason that they’re not considered acceptable today is because they give results that people don’t want to hear.

Juicy Excerpt #2: The three methods that I’ve described are not rocket science. These methods are recognized by any person familiar with analytical forecasting. Any of these people could have predicted a coming stock market crash any time in the last five years, just as I did in 2002. So the answer to the question, “Why did everyone else miss it?” is that they don’t want to know.

Juicy Excerpt #3: The arrogant pundits and journalists and financier and bankers that you hear every day on CNBC and other stations, and read in the Wall Street Journal and other newspapers are perfectly capable of understanding what I’ve written here.

Study #9 Showing That Buy-and-Hold Is Dead – What Risk Premium Is Normal? Robert D. Arnott and Peter L. Bernstein

Juicy Excerpt #1: The observed real stock returns, and the excess return for stocks relative to bonds, over the last 75 years has been extraordinary, due largely to important nonrecurring developments.

Juicy Excerpt #2: It is dangerous to shape future expectations based on extrapolating these lofty historical returns. In so doing, an investor is tacitly assuming that valuation levels that have doubled, tripled and quadrupled, relative to the underlying earnings and dividends, can be expected to do so again.

Juicy Excerpt #3: The current risk premium is approximately zero and a sensible expectation for the future real return for both stocks and bonds is around 2 percent to 4 percent, far lower than the actuarial assumptions on which most investors are basing their planning and spending.

Juicy Excerpt #4: The consensus, that a “normal” risk premium is around 5 percent, was shaped by a deeply rooted naivete in the investment community, where most participants have a career span reaching no further back than the monumental 25-year bull market from 1975 to 1999.

Juicy Excerpt #5: A negative risk premium, as appears to prevail today, is a symptom of irrational valuation. As a consequence, investors greedy enough or naive enough to expect a 5 percent risk premium, and overweight equities accordingly, may well be doomed to deep disappointments in the future as the realized risk premium falls far below this inflated expectation.

Links to additional studies (and to more Juicy Excerpts!) showing that buy-and-hold is dead are set forth in Part Two of Buy-and-Hold is Dead — These Studies Prove It! 

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