Set forth below is the text of a comment that I recently put to another blog entry at this site:
Madoff was running a ponzi scheme, a$$wipe. It has zero to do with buy and hold. Regardless of your strategy for buying stock, you are still holding stock/bonds. It is just a matter of when you buy and sell (or don’t sell). The two have nothing do with each other.
Have you read Shiller’s book, Anonymous? If you have not done so, you need to do so. If you have done so, you need to read it again. I am not saying that as a dig. I have read it four times and I have learned important new things each time I read it.
Shiller explains in his book that, because of the way the market is set up, our default assumption should be that the U.S. stock market IS a Ponzi scheme; we should give consideration to the idea that it is not a Ponzi scheme only if strong evidence is presented that this is the case. And please remember that there is 140 years of return data backing Shiller up on this. There is NO evidence pointing in the other direction. Common sense says that the U.S. market should be assumed to be a Ponzi scheme and 140 years of return data shows that in fact that is what it has always been.
When I say “the way it is set up,” what I am referring to is the fact that it is investors in the market who set the prices of the shares they own. If I handed ten employees of my company blank checks and said “this is in payment for the services you provided last year, you can fill in any number you like but you all must agree on the same number,” what do you think are the chances that they would choose a number that reflects fair value for their services? The chances are ZERO.
You are ignoring centuries of evidence as to how human nature works to think those ten people would assign themselves fair payment for the work they did. They might not assign themselves 20 times fair payment. They need to live with themselves. So there would be a voice inside them telling them “don’t go too absurdly high.” But they would go at least somewhat absurdly high all the same. It is not hard to imagine them assigning themselves three times fair value, which is what those who owned shares in the U.S. stock market assigned themselves in 2000. That’s human nature.
All markets that work have a counter to this flaw in human nature. Car dealers would like to ask $90,000 for cars that are properly valued at $30,000. The reason why the car market works is that there exists a counter to their desire to do that. The car dealer who sets his prices at three times above fair value is driven out of business by the competition. His customers educate themselves as to fair value and refuse to pay too much more than that when buying a car.
That’s the element that is lacking in the stock market whenever Buy-and-Hold strategies become popular.
If we could educate people about how much return is reduced when prices go to insanely high levels, the stock market would work just the way the car market works. We collectively would have a desire to push prices up, just as we do now. But some among us would sell their stocks whenever we did that and those sales would CORRECT for our greed. Prices could never again get out of hand once we opened the internet to honest posting because investors would be informed that letting prices go too high is not in their best interests.
Participants in a market must be INFORMED as to what is in their best interests for the market to function properly. Buy-and-Hold was built on a mistaken understanding of how markets work and the Buy-and-Holders are dead-set determined to block the spread of knowledge of what we have learned from the last 34 years of peer-reviewed research. Until that problem is addressed, the stock market cannot function like other markets. The only means by which it can bring prices down is through crashes. And crashes hurt us all in very serious ways.
The U.S. stock market is a Ponzi scheme whenever it is wildly overpriced, as it has been since 1996. Shiller says this in his book and there is now 34 years of peer-reviewed research showing that what he says is indeed so. The only reason why everyone who knows anything about stocks doesn’t know this today is that the Buy-and-Hold Mafia is so ruthless in its use of intimidation tactics that the people who know the story are afraid to tell what they know in language clear enough for most of the rest of us to fully appreciate what they are saying.
Your point that people who buy U.S. stocks own something real is only partly correct. The stock market in 2000 was comprised of one-third real stuff and two-thirds cotton-candy nothingness. P/E10 is the metric that tells us how much reality there is to the market at any given point of time. That’s why we all need to know about it and make use of it.
It’s of course a good thing that the market was one-third real rather than 100 percent fake in 2000. But the dollar value of the cotton-candy nothingness in the U.S. market was many, many times bigger than the dollar-value of the cotton-candy nothingness in the Madoff fund. Jack Bogle is Bernie Madoff timed 5,000 re the number of human lives he has destroyed. Not intentionally. I get that. But still…
You show with your own behavior that you know this to be so on one level of consciousness. So does Bogle. So does Burns. So does Shultheis. So do all the others. We ALL know it to be so. The question before us is when we are going to acknowledge openly what we know deep down inside and thereby empower ourselves to take constructive and productive and life-affirning steps. Each day that we delay we cause more human misery. Each time the human misery we have caused increases, the shame we feel for our failure to act thus far increases.
But at some point we must act. There is no other way out of this economic crisis. Given that we must act sooner or later, it is better to do it sooner, when the human misery we have caused and the shame we feel for causing that misery is less.
The U.S. stock market becomes a giant Ponzi scheme whenever Buy-and-Hold “strategies” become popular. Common sense and the entire historical record and the behavior of the Buy-and-Holders when they are challenged by the findings of the past 34 years of peer-reviewed research all show this to be so.
I am not your enemy, Anonymous. Your enemy resides within you. Your enemy is the Get Rich Quick urge that causes you to behave in the manner in which you have behaved for the past 13 years. The job of an investment advisor is to help you CONTROL that Get Rich Quick urge, not encourage you to give in to it to the greatest extent imaginable.
That’s my sincere take re these terribly important matters, in any event.
I naturally wish you the best of luck in all your future life endeavors regardless of what investing strategies you elect to pursue, my old friend.