I’ve posted Entry #523 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Views on How Stock Investing Works Are Hard to Change Because the Subject Is So Darn Important.
Juicy Excerpt: It is not only the importance of correcting a mistake that causes us to correct one. It is also the extent of the investment that we have made in the wrong way of doing things. We can stick with decisions with devastating consequences for a long time if we have a lot invested in them.
Uh oh. Once again, Robert Shiller says Rob Bennett is wrong.
https://www.project-syndicate.org/commentary/making-sense-of-soaring-stock-prices-by-robert-j-shiller-et-al-2020-11
First of all, Shiller is pointing out that the low interest rates (not buy and hold) are driving up stocks:
“ Market observers have noted the potential role of low interest rates in pushing up CAPE ratios. In traditional financial theory, interest rates are a key component of valuation models. When interest rates fall, the discount rate used in these models decreases and the price of the equity asset should appreciate, assuming all other model inputs stay constant. So, interest-rate cuts by central banks may be used to justify higher equity prices and CAPE ratios.
Thus, the level of interest rates is an increasingly important element to consider when valuing equities. To capture these effects and compare investments in stocks versus bonds, we developed the ECY, which considers both equity valuation and interest-rate levels. To calculate the ECY, we simply invert the CAPE ratio to get a yield and then subtract the ten-year real interest rate.”
Despite Rob telling us that Shiller thinks the market is about to crash, he actually says that the market looks attractive:
“ But, at this point, despite the risks and the high CAPE ratios, stock-market valuations may not be as absurd as some people think.”
And
“ But with interest rates low and likely to stay there, equities will continue to look attractive, particularly when compared to bonds.”
Shiller already told you not to time the market with CAPE, but you wouldn’t listen and you paid the price. Here he is again, explaining how continue to be wrong. There goes your $500 million windfall.
That’s an important article, Anonymous. Thanks for bringing it to our attention.
I have been saying since the morning of May 13, 2002, that we need to open every discussion board and blog on the internet to honest posting re the last 39 years of peer-reviewed research in this field, without a single exception. This article is the sort of fruit that we see develop from permitting honest discussion. Shiller is offering views that we have not heard before, Everyone who works in this field should be taking the points he makes here into consideration and incorporating them into their own views as to how stock investing works. I will write a column for the Value Walk site offering observations on this article.
My initial reaction is not to be entirely persuaded by the points that Shiller makes here. It certainly makes sense that low interest rates make stocks look more appealing in relative terms. But I don’t agree that: “Despite the risks and the high CAPE ratios, stock-market valuations may not be as absurd as some people think.” Interest rates are today very low. It seems unlikely that they will remain that low for long. What happens when interest rates rise? Just as a lowering of interest rates brings stock prices up, an increase in interest rates brings stock prices down.
If stocks were priced low at a time when interest rates were low, the pressure on stock prices to fall when interest rates rose would not be so great — they would already be low. But it seems to me that we are in a doubly risky situation today, There is pressure on stock prices to fall because they are so high. And there is added pressure on stock prices to fall because interest rates are so low that they can only go up. How are stock prices going to rise if they are already at insanely high levels at a time when low interest rates are giving stock prices a big boost?
I think it would be fair to say that today’s low interest rates go a long ways to EXPLAINING today’s high stock prices. That I can buy. But the risk that those prices are going to fall hard in the not-too-distant future is still present. If anything, it is worse than it would be if interest rates were high today. If interest rates were high today, stock investors could hope that interest rates would drop and give stock prices another boost. That cannot happen with interest rates where they are today.
He says that the low interest rates are “likely to stay there.” He doesn’t say why he believes that. Economic conditions do not remain the same indefinitely. Every crash that we have seen was unexpected. If it had been expected, that expectation would have brought stock prices down and diminished the size of the crash. It is when investors stop worrying about a crash that the danger of a crash is the greatest. I see this as an article that will cause many investors not to worry so much about a crash. It is my view that people should be very worried.
Please remember that interest rates are “priced in” to the market price for stocks. But irrational exuberance is never priced in. It is the one factor that by definition cannot be priced in because the process by which factors are priced in is a rational process and irrational exuberance takes place outside of rationality (the rational thing would be for investors to price stocks properly).
I believe that Shiller has advanced the ball with this article. It gives everyone in the field something to think about. I look forward to seeing what lots of smart people have to say about it.
My sincere take.
Rob
Like I said, Shiller doesn’t agree with you. He never has. You just need to get with reality and accept it.
He doesn’t agree with me on every last thing, Anonymous. But of course he doesn’t agree with you on every last thing either.
He agrees with me that irrational exuberance is a real thing, If that’s so, then the safe withdrawal rate is not the same number at all times but a number that changes depending on the amount of irrational exuberance present in the stock price at the time. That’s the matter that caused you Goons to go nuts. If Shiller agrees with me re that one, I think it would be fair to say that we should be permitting honest posting re that one at every discussion board and blog on the internet, without a single exception.
Fair enough?
Rob
Maybe the goons got to Shiller. Darn those goons. They have millions of people around the globe, stopping VII in its tracks.
A measure of gooniness resides within each and every one of us, Anonymous. Shiller wants to be liked by other people, as do we all. If he states clearly that one-half of today’s stock market value is nothing more than irrational exuberance that will be disappearing into the mist in not too long a time, he is going to disappoint millions of people who have plan for how to use that money to enhance their enjoyment of life. People are going to be upset with him if he says that.
In the long run, people will be even more upset if he doesn’t say it. We are all better off knowing the realities. But it’s not an easy thing to state them clearly and firmly and simply. I think that Shiller will be saying things more clearly in the days following the next Buy-and-Hold Crisis. And I think lots of others will be doing so as well. So I think that we are on the threshold of achieving some amazing advances in our understand of how stock investing works. We will probably need to live through an ocean of human misery before getting to the other side. But we are in the process of achieving something truly wonderful.
I naturally wish you all good things.
Rob