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 more risky when prices are high”
This is the kind of thinking that lead you to confidently predict the market was going fall 50% within three years a few years ago. The rest of us stuck to our buy and hold strategies, and were rewarded for it.
Financial markets have no memory, and don’t adhere to any fixed scientific rules of nature.
You were not rewarded, Anonymous. If you want to say that you were TEMPORARILY rewarded, I could go along with that. Your portfolio number is bigger than it would have been had you lowered your stock allocation. But if 50 percent of the portfolio number represents irrational exuberance rather than economic realities, then any rewards that you have experienced are only temporary. When they go “poof!,” where are you going to be then? You will be down financially and you will have lost years that could otherwise have been put to use making up for those losses. A good argument could be made that, the longer it takes for the temporary gains to go “poof!”, the worse off you are.
I don’t want temporary gains. I want real gains. I don’t think that others should want temporary gains either. Now, it is not for me to tell others what to do. There are lots of good and smart people who love Buy-and-Hold. I wish them the best of luck with it. But it’s something else for me to endorse this strategy that I find so dangerous. People should do what they think is best. But no one has a right to demand my endorsement for something that I find dangerous. That’s a bridge too far.
Financial markets DO have a memory. That’s precisely what Shiller showed. If markets did not have a memory, returns would play out in the pattern of a random walk. That’s why the famous book that popularized Buy-and-Hold was titled “A Random Walk Down Wall Street.” Shiller’s book has a different title. Shiller’s book is titled “Irrational Exuberance.” Shiller showed that valuations affect long-term returns. That couldn’t happen unless the market had a memory. Do you think that valuations have just randomly been affecting long-term returns for 150 years now? Valuations affects long-term returns because the market remembers when prices go up due to irrational exuberance rather than economic realities and then it erases those temporary gains in time because the market’s ultimate objective is to get prices right.
I don’t quite get what you are trying to say when you say that markets don’t adhere to fixed scientific rules of nature. Markets operate in some way. The question that we all should be trying to determine is — HOW do they operate? We need to know how the stock market operates if we want to invest effectively.
The Buy-and-Holders advanced a theory as to how the stock market operates. They said that the market is efficient. That means that all factors known to affect price are taken into consideration in the setting of the price. Another way of saying it is that the market price is determined by rational actors, people trying to achieve their best interests. Shiller’s wife is a psychologist. So he knows that humans are not purely rational actors. He knows that they can be swayed by emotion. So he had doubts about this idea that investing is a purely rational business and he tested it scientifically. He found that, indeed, stock prices are set by a HIGHLY emotional process. And he gave us a tool (P/E10) to determine how emotional the market is at a given point in time so that we can protect ourselves from the effects of all the craziness.
If the market were rational, do you think we would have seen death threats? Board bannings? Thousands of acts of defamation? Threats to get academic researchers fired from their jobs? Those are emotional phenomena, Anonymous. We see that stuff because the Buy-and-Holders cannot bear to hear what the last 37 years of peer-reviewed research tells us about how stock investing works. The rational response would be for the Buy-and-Holders either to integrate the new research into their thinking or to try to form a rational case for why they reject it. A death threat is not a rational case. Neither is a board banning. Neither is an act of defamation. Neither is a threat to get an academic researcher fired from his job. The behavior of you Goons shows that Shiller was right. You would not be so upset if you were confident that your investment strategy was a realistic one.
There is going to be a national debate re these issues, Anonymous. The matters in dispute are too important to the futures of too many people for there not to be a national debate. If I were king of the world, that debate would have been launched on the afternoon of May 13, 2002. Or, better yet, in 1981, when Shiller’s “revolutionary” (his word) Nobel-prize-winning research was revealed to the world. We all would be better off today had the national debate been launched at one of those earlier times.
But here we are, you know? We cannot hold off on the launching of the national debate indefinitely. It is just too important for that national debate to take place. So we will launch it in the days following the next price crash. Not my preference, you know? Not by a long shot. But it’s an outcome a lot better than any alternative realistically available to us at this point in the proceedings. It appears to me that we are just going to have to accept these somewhat mixed realities, make the best of it that we can, and move on to a better place for each and every one of us.
The market has a memory. Otherwise prices would play out in the pattern of a random walk. That’s my sincere take, in any event.
National-Debate Launching Rob
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