Set forth below is the text of a post that I recently put to the Quora site:
Is Andrews Smithers Right When He Says That U.S. Stocks Are 80 Percent Overvalued and That We Are in a Bubble Right Now?
Yes, he’s right.
I have studied this matter in great depth. I have spent the last 12 years of my life studying it. Smithers is a top-notch guy. He is NOT a doom-and-gloomer. He is a straight-shooter. He is kind and intelligent. His statements are rooted in a wealth of research.
What is hard for people to understand is how so many good and smart people could continue to tell us to buy stocks when the research shows that stocks are priced at such insanely dangerous levels. The only way to make sense of that is to understand the history of how our knowledge of how stock investing works has developed over time.
Prior to the 1960s, we were in the pre-historic days of our understanding. Stock investing was not the subject of systematic peer-reviewed research. People offered opinions as to how stock investing works. It was pretty much just guesswork in those days.
The first big breakthrough came in 1965, when University of Chicago Economics Professor Eugene Fama published research showing that short-term timing (changing your stock allocation because of a belief as to where prices are headed in the next year or so) does not work. This finding formed the foundation of the Buy-and-Hold concept. 90 percent of the advice you hear today about stock investing is rooted in Fama’s finding and its implications.
People were very excited about this finding and they thought that it was the endpoint of our journey. It turned out that they were wrong. Fama really just took us into the Dark Ages, a time when we knew a lot more than we knew in the Prehistoric Ages but not nearly as much as we would come to know in future days. It was Yale Economics Professor Robert Shiller who supplied the final piece of the puzzle that we needed to finally make complete sense of stock investing.
Shiller did this in 1981. He showed that long-term timing (changing your stock allocation in response to big valuation shifts with the understanding that you may not see benefits for doing so for as long as 10 years) ALWAYS works and is always 100 percent REQUIRED for investors hoping to have any realistic hope of achieving long-term investing success.
Fama wasn’t entirely wrong. It really is so that short-term timing doesn’t work. Unfortunately, Fama stated his conclusions in a sloppy way. He didn’t say that “Short-term timing does’t work,” which is so. He said that “Timing does work,” which is not so. One form of timing (long-term timing) ALWAYS works and is always 100 percent REQUIRED. So Fama’s ideas took us to a very, very dangerous place.
Long-term timing is price discipline. Markets cannot function without price discipline. The thing that makes the car-selling market work is that buyers are always trying to get a good price and so sellers cannot overcharge and get away with it. So long as that dynamic remains in place, the car-selling market can assign prices to cars that are roughly right.
Investors who believe in Buy-and-Hold do not exercise price discipline. They do not spend less on stocks when prices reach insanely dangerous levels, levels at which the long-term return on stocks is less than the long-term return on far safer asset classes like Certificates of Deposit. They stick to the same stock allocation NO MATTER WHAT.
Price discipline is like the brake on a car. The stock market in a time when Buy-and-Hold strategies have become popular is like a car from which the brakes have been ripped out. It is a car headed for a crash.
There is now 33 years of peer-reviewed research, based on 140 years of stock-market history, showing this all to be true. So why doesn’t everyone know about it?
The experts in this field have painted themselves into a corner. They believed in Buy-and-Hold. They built their careers around promotion of it. Then research was published showing that it is not just a little bit off the mark but wildly off the mark. They experienced cognitive dissonance. They couldn’t bear to acknowledge publicly that they were wrong about something so basic. So they have been in cover-up mode for years now.