I’ve posted Entry #204 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called What Economists Say About Shiller’s Nobel Prize.
Juicy Excerpt: “We have big important questions that remain largely open and we have giants bringing evidence to bear. And the answer turns out to be more complicated than markets are efficient — or markets are inefficient.”
Yes. The toughie is — How can both Fama and Shiller be right? My take is that Fama is right that the market longs to be efficient and would be efficient if only investors had access to the information and tools needed for them to exercise price discipline when buying stocks (as they do when buying all the other goods and services offered in every type of market other than the stock market). Fama’s tragic mistake was jumping to the conclusion that the reason why short-term timing doesn’t work is that prices are set rationally — The real reason is that it is investor emotion that determines prices in the short term and emotion is unpredictable stuff.
Add Shiller’s insight (that prices are determined by emotion in the short term) to Fama’s (that the market must get the price right eventually because that is what markets do) and you’ve really got something. We don’t need to reject Fama’s insights, we need to look at them in a new light informed by Shiller’s insights. Both “sides” have something powerful to contribute.
If only the Buy-and-Holders could calm down enough to see that acceptance of Shiller’s contribution brings them to the place that deep in their hearts they really want to be.