Set forth below is the text of a comment that I recently posted to the discussion thread for another blog entry at this site:
“Stocks are today priced at two times fair value.”
To be clear, this is a fact Wall Street is not aware of – otherwise they would immediately dump stocks. Is that fair to say?
You are making a great point here, Anonymous. If you would reflect on this point a bit, the entire matter would click for you.
Just about everybody on Wall Street is aware intellectually of what the P/E10 level is today. You see it mentioned all the time in articles. These people are obviously not dumb. So on an intellectual level, they know what they need to know.
But they have not emotionally taken in the knowledge that they possess so that they can make productive use of it. They rationalize away this knowledge that they possess. They tell themselves “oh, nobody knows when the crash is coming and I cannot afford to miss out on gains in the meantime” or whatever. The knowledge that they possess sits in their brains but they have not integrated it with their other thoughts on all of the various strategic questions and so it is as if the knowledge did not exist. It is passive knowledge. It is not being put to productive use.
It helps to remember what happened in the famous psychology experiment from the 1950s, the Asch experiment. People were put in a room and asked to identify which of two lines — a 12-inch line and an 18-inch line — were longer. Their brains possessed all the knowledge needed to supply the correct answer. It was obvious to them that the 18-inch line was longer. But the four people who were plants and who spoke before them all identified the 12-inch line as longer. This psychological reality neutralized the knowledge they possessed. Humans are social creatures. Evolution put something within us that tells us “don’t go against the tribe no matter what your brain tells you.” So they told the person conducting the experiment that they “thought” the 12-inch line was the longer one. Their emotions cancelled out the product of their mental processes.
All of these people on Wall Street “know” what it means to say that stocks are priced at two times fair value, Anonymous. But their emotions — their need not to defy the tribe — cancels out the effect of their mental processes. So they don’t give voice to what they “know.” They say: “timing doesn’t work” or repeat some other mind-numbing marketing slogan.
Prior to 1981, we were as a people largely ignorant of the effect of valuations on long-term returns. Shiller was awarded a Nobel prize because he published research in 1981 that in an intellectual sense dispelled that ignorance. Now we “know” how stock investing works. But it doesn’t do us any good to possess this “knowledge” if we cannot act on it. I am trying to take things to the next step, to win for us the ability to DISCUSS what we now know so that we can integrate it with our other thoughts on the subject of investing and thereby become able to make better strategic decisions.
That’s the story here. Do we begin to make collective use of the last 36 years of peer-reviewed research in this field or do we elect to remain in effective ignorance and suffer the consequences of doing so? I of course say that we need to move forward, that all of our social norms favor open discussion of peer-reviewed research and that there is no way to hold back the tide of history re these matters indefinitely.
If we all talked openly about the overvaluation problem, the overvaluation problem would go away. Shiller SOLVED the one big problem of stock investing — the risk attached to it. The peer-reviewed research that I co-authored with Wade Pfau shows that the risk that has always been associated with stock investing pretty much goes away once people are permitted to take the findings of the last 36 years of peer-reviewed research into consideration when making allocation decisions.
But people do need to be able to discuss these matters to be able to gain the power to overcome their unfortunate emotional inclination in favor of Get Rich Quick thinking. It is only by opening every discussion board and blog on the internet to honest posting re the last 36 years of peer-reviewed research that we can put those research findings to good use, that we can at last come to truly “know” what Shiller showed us 36 years ago. We need to enforce our laws against financial fraud. Those are good and necessary laws. They are a key part of the system that permits the American Experiment as a whole to work its magic.
Good question.
Rob
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