Buy and Holders Must Sell Their Stocks Before the Economy Can Recover

Beyond Buy-and-Hold #63

By Rob Bennett

If stock prices continue their 12-year march downward, we are going to end up in the Second Great Depression. So we would all like to see a turnaround. The thing with which there is a difference of opinion is the question of what we need to see to bring on this happy event.

Buy-and-Holders believe that it is economic developments that cause stock price changes. If that is so, what we need is an economic recovery. That?s obviously a good thing. So, from a Buy-and-Hold perspective, we all just have to wait for and hope for an economic recovery.

Stock prices are the root of economic crises

Valuation-Informed Indexers have a very different understanding of how stock investing works. We don?t believe that it is economic developments that determine stock prices but that it is stock prices that determine economic developments. Once stocks become insanely overpriced, a crash becomes inevitable and, once a crash becomes inevitable, an economic crisis becomes inevitable because the price crash subtracts so much spending power from the economy.

It makes no sense for Valuation-Informed Indexers to wish for an economic recovery. We cannot realistically expect to see that until stock prices stabilize. We need to be rooting for a stabilization in stock prices.

What could bring that about?

Emotion and stock prices

Overvaluation and undervaluation are the product of investor emotion. Rational investors would price stocks properly. So the market can become stabilized only when investor emotionalism is diminished.

Now —

What would be the effect of a price increase? Would a price increase make investors more or less emotional?

A price increase would make investors more emotional. It?s only when stocks are priced properly that investors can assess stocks rationally. From the standpoint of Valuation-Informed Indexers, we need a price drop.

The trouble is that investors have already suffered years of poor stock performance. Another price drop is going to bring on investor depression. Once prices have fallen to fair-value levels, conditions will be in place to cause prices to fall to levels far below fair value.

How far can the stock market fall?

It?s no accident that prices have fallen to one-half fair value in the wake of every major bull market in U.S. history. That?s roughly a 65 percent price drop from where we stand today.

How many Buy-and-Holders do you think will be sticking with their high stock allocations in the wake of another 65 percent price drop?

Perhaps three? Perhaps two? Perhaps one?

Perhaps zero?

Has there ever been a Buy-and-Holder who stuck with his high stock allocation through an entire bull/bear cycle? If there has been, I?d be grateful if someone would pass along his name. I have certainly never heard of one being identified. The fact that none of the advocates of Buy-and-Hold has ever been able to identify a single investor who stuck with the strategy for the long term has always made me skeptical of whether this Buy-and-Hold business is as realistic as its proponents make it out to be.

The best of times for stock market investors

There?s a word in the investing literature used to describe the state of play that arrives when the last Buy-and-Holder gives up the ghost and sells his stocks at huge losses: Capitulation.

There?s a reason why the market can turn up again only after capitulation has been achieved. The thing that sends prices wildly up in bull markets is investor emotion. The purpose of a bear market is to wash the emotion out of the market. So long as there are still people claiming that Buy-and-Hold can work, capitulation has not been achieved. For our economy to recover, losses must first get bad enough to persuade the last Buy-and-Holder to give up the ghost.

The idea that Buy-and-Hold can work is a logical impossibility. Wishing for a world in which all Buy-and-Holders do not suffer financial wipeouts is like wishing for the discovery of a perpetual motion machine. We can all easily see the appeal of the concept. It is not possible for any of us to imagine an alternative universe in which the fantastic dream could be made concrete and practical and real.

I am hoping for the Buy-and-Holders to sell soon. Not because I don?t like them. Not because I intend to laugh at them. Not because I long to say ?I told you so.?

I am hoping for the Buy-and-Holders to sell soon because it is when the last Buy-and-Holder sells that we can begin rebuilding our economic system after the damage done to it during the worst of all bull markets we have ever endured as a nation. I am sick of the human misery we see all about us as a consequence of the temporary triumph of Get RIch Quick thinking. I want to stop waiting for more inevitable bad scenes to play out and resume enjoying economic growth extending its bounty far and wide.

I don?t wish for an economic recovery. Because I view that as a vain wish.

I wish for a collapse of belief in Buy-and-Hold. Because I believe that?s what we need to see for the conditions to fall in place that will permit the greatest economic recovery ever seen in our history.

Rob Bennett believes that by studying the historical return data we can advance our understanding of how stock investing really works. His bio is here.


Related Posts:

This is the Best Time in History to be a Stock Investor
The Second Depression Cometh
Am I Crazy For Being Out of the Stock Market for 14 Years?
Your Retirement Plan is in More Trouble Than You Realize
Nine Reasons Why Stock Valuations Make a BIG Difference in the Long Run
Risk-Free Stock Investing?

( Photo from Flickr by Helico )

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