I’ve posted Entry #188 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Shiller’s Mistaken Understanding of Why Only Long-Term Returns Are Predictable.
Juicy Excerpt: The term “noise” suggests a meaningless factor, a factor that need not be given much consideration. The Buy-and-Holders are using the term properly, Shiller is not.
Buy-and-Holders believe that the returns of greater than 6.5 percent real and the returns of less than 6.5 percent real pop up randomly. Returns are determined by unforeseen economic and political events, in the Buy-and-Hold Model. Thus, deviations from the normal return cannot be predicted. The deviations are noise, distractions from the reality you should be keeping in mind at all times, the reality that the average long-term return is 6.5 percent real.
Under Shiller’s model, the deviations are NOT random and meaningless events. The reason why returns are predictable in the Shiller model is that the model posits that it is investor emotions that are the primary determinant of price changes. Emotional extremes in one direction beget in time emotional extremes in the opposite direction. High prices increase the probability of price drops and low prices increase the probability of price rises. There’s nothing “noisy” (or random, or meaningless) about this process. It is the essence of how stock investing works, according to the Shiller model.