I’ve posted Entry #395 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Buy-and-Hold Is Adam Smith Economics Applied to Stock Investing.
Juicy Excerpt: I think that a big reason for the delay in the spread of Shiller’s ideas is that the alternative to Shiller’s model — Buy-and-Hold — has roots that go very deep. Eugene Fama is the economist who did the most to lend theoretical support to the Buy-and-Hold Model. But the general way of thinking about how money transactions work that informs the Buy-and-Hold Model really began with Adam Smith and Adam Smith’s ideas inform the thinking of every economist alive. When an economist is asked to question his belief in Buy-and-Hold, there is a very real sense in which he is being asked to question his belief in things he learned in the first textbooks on economics that he ever read.
It was Adam Smith who promoted the concept of a “Rational Man” who makes the economic choices that best advance his self-interest. Isn’t that what Buy-and-Hold is all about? Buy-and-Holders believe that the market is efficient, that is, that it is always properly priced. Why is the market properly priced? Because we are all acting in our self-interest. If some of us noticed that the others of us had priced stocks improperly, we would swoop in and exploit the mispricing to our benefit. The reason why Buy-and-Holders believe that it is not possible for market timing to work is that one can successfully time the market only by outsmarting it and it is hard to imagine how anyone could be smarter than a market of millions each acting rationally in pursuit of his or her self-interest.
Shiller is saying something very different. He is saying that it is shifts in investor emotions, not economic realities, that are the primary drivers of stock price changes. Investors who permit emotion to steer their investing choices are not acting in their self-interest, they are acting irrationally. Of course they are not even aware that they are failing to act in their self-interest. In the Shiller model, investors hurt themselves by giving in to emotional impulses to push stock prices ever higher and individual investors who possess the ability to see through the irrational exuberance can indeed profit by being smarter than an overall market that is not very smart at all.
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