Set forth below is the text of a comment that I recently posted to the discusson thread for another blog entry at this site:
It is not proper when there is no error, as thousands have pointed out. Did Wade Pfau say there was an error? No. Did Shiller say there is an error? No.
Pfau said: “Yes, Virginia, Valuation-Informed Indexing works!” Valuation-Informed Indexing calls for market timing in response to shifts in valuations. Buy-and-Hold discourages market timing. To say that Valuation-Informed Indexing works is to say that the claim of Buy-and-Holders that market timing doesn’t work or is not required is in error.
The title of Shiller’s book is “Irrational Exuberance.” The reason why the people who developed Buy-and-Hold concluded that market timing is not required is that they believed that the market is efficient. That’s another word for saying that the market is rational. The idea is that investors take into consideration all developments that affect the return on stocks when setting the price of stocks. It would be rational to do that, not irrational. Shiller is saying that for emotional reasons investors do not take into consideration all developments that affect the price of stocks. To say that investors are irrational is to say that Buy-and-Hold is in error.
It’s not thousands who today say that there is no error in the pricing of stocks, it is millions. It is all stock investors. To the extent that the millons of people who owned stocks today believed that the price of stocks is in error, they would correct it. Today’s stock investors are living in delusion, Anonymous. A CAPE value of 30 is a CAPE value of deliusion. Irrational exuberance is a delusion. Development of the Buy-and-Hold strategy did not create the delusion. Stock investors have been living in delusion ever since the first stock market was opened for business. Every bull market is an act of delusion. If investors were not deluded, they would price stocks properly. There would be no overvaluation.
The error is not really an intellectual error. It is an unfortunate inpulse inherent in human nature to want to get something for nothing. Stock investing is dominanted by this impulse because it is investors who set the price of their stocks. Investors possess the power to vote themselves raises whenever they please and, so long as no one mentions the reality that the pumped-up price is going to disappear in time, the pretend money appears to be real and makes the human investors feel good. The error is believing that the pumped-up prices are real.
Awareness of the error corrects it. Stock investors do possess the capacity for rationality. When they become aware that there is irrational exuberance present in the current stock price, their rationality causes them to engage in whatever amount of market timing is required to get their risk profile back to what they had wanted it to be when they started investing. So irrational exuberance is self-correcting SO LONG AS INVESTORS HAVE EASY ACCESS TO THE INFORMATION NEEDED TO MAKE RATIONAL CHOICES. A ban on honest posting neutralizes the part of the brain that wants to make rational choices by permitting the investor to enjoy his delusion without the unccomfortable feeling that he has permitted his risk profile to get out of whack.
The error is in human nature. We all want something for nothing. So we are all drawn to Buy-and-Hold/price indifferent strategies. It’s not an intellectual error, it is an emotional error. Anytime someone observes that “stocks are overpriced today,” they are saying that there is an error. To misprice stocks is to make an error. The purpose of market timing (the long-term variety, not the short-term, variety) is to correct errors, to get prices back to where they should be. Market timing is the thing that brings rationality (the correction of errors) into the stock buying process.
Someone who says that there is no error is saying that there is no mispricing, that there is no overvaluation. Do you say that stocks are priced properly when the CAPE value is 30?
Rob
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