I’ve posted Entry #719 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Irrational Exuberance Is a Silent Killer — Unless Someone Draws Attention to It, Life Goes On As If It Didn’t Exist.
Juicy Excerpt: What if we learned that the traffic lights on our roads don’t work and that a car might be heading at us at full speed from the other direction when the green light tells us that it is safe to roll on through the intersection? Those lights need to work. If the traffic lights are not working, it’s not safe to get on the road. I am sure. Driving without traffic lights makes no sense. Having one’s retirement money in stocks at a time when the CAPE value is 37 (where it stands today) is akin to driving at a time when the traffic lights aren’t working.
There have been bubbles since long before anyone thought of buy and hold.
The issue is that your fantasy world of steady high returns from stocks is not compatible with human nature or reality/
It’s true that there have always been bubbles. The difference today is that we now have 43 years of peer-reviewed research showing us how to stop them from forming. We have learned things that we did not know in earlier times and thereby gains the ability to live better lives.
All that we are talking about is investing rationally. Humans employ reason in many fields. I see no reason why they would not be able apply it in the stock investing field. No it perfectly, probably. But I believe that we could do a lot better than we are doing today.
Rob
“The difference today is that we now have 43 years of peer-reviewed research showing us how to stop them from forming.”
Free markets means that buyers are allowed to offer whatever amount of money they want to a seller. You may not like how much money they are offering because you would like to buy those goods at a lower price.
There is simply no way we can get your world of high returns and low risk, and if we somehow did arrive there we would know that the free market is not operating.
We disagree. The U.S. economy is sufficiently productive to support a stock market offering high returns. And our knowledge on how stock investing works is today sufficiently advanced to permit risk to be taken to very low levels.
The idea that it is high risk that causes high returns is one of the things that the Buy-and-Holders got all. Risk was never higher than it was in early 2000 and the expected 10-year return at the time was a negative number. Irrational investors are not compensated for taking on crazy levels of risk. And rational investors can receive good returns without needing to take on much risk because the economic system is sufficiently profitable to support good returns to rational investors.
You frequently make the mistake of ASSUMING rationality, Evidence. That is the quintessential Buy-and-Hold mistake. The Buy-and-Holders have never demonstrated that investors are rational. The entire history off the market shows otherwise. They assume it. That’s not at all the same thing. Real science is not about what assumptions you can dogmatically cling to. It is about what you can show to be so with research.
There has never been any showing that valuation-based market timing (price discipline!) is not 100 percent required of every investors. Buy-and-Holders claim it all the time. But not once have they shown it to be so with research.
Rob
“ We disagree.”
If you disagree, then don’t buy stocks and keep doing what you are doing. Look at how it has all worked out for you so far.
Mark me down as saying I don’t want an outcome like you.
Is it okay with you if I mention at the boards and blogs at which I participate that I do not believe that the Greaney retirement study contains a valuation adjustment?
Rob
“The U.S. economy is sufficiently productive to support a stock market offering high returns.”
You demonstrate that you don’t understand where stock returns come from. The price paid determines the return.
If I told you that an investment will pay $1 per year could you tell me how much your return would be without knowing how you paid. Of course not.
If your magical low volatility, high return asset existed people would flock to buy it driving up the price and driving down the return.
The only way that would not happen is if nobody noticed what a great deal was available.
The only thing that would change in a world in which people took the last 43 years of peer-reviewed research into consideration when buying stocks is that prices would not get pumped up artificially and so they would not then need to collapse artificially.
Stocks would be a great deal, that’s so. But they are a great deal now on average. The only thing that would change is that there would not be these times when they temporarily appear to be even a greater deal than they really are. Irrational exuberance is an illusion. Taking it away would be to everyone’s good. So,yes, stocks would be more appealing than they are today. Because the illusion of temporary wealth that is irrational exuberance would be removed. That illusion hurts people.
You seem to believe that taking away the illusion must be paid for in some way. Why? Illusions are bad. We are a fortunate people that we now have 43 years of peer-reviewed research revealing the illusion to us. All that we need to do to live better lives is to take advantage of what we have learned. That’s it. That’s how learning works. That’s why learning stuff is considered a good thing.
I believe that, when stocks become more appealing, it may be that low-risk asset classes will need to offer higher returns because their appeal relative to stocks will diminish when the riskiness of stocks diminishes. Is that a bad thing? I see it as a good thing. If that happens, it means that the returns offered by low-risk asset classes were artificially suppressed because people were investing in stocks in irrational ways and thereby pushing the riskiness of stocks higher than it needed to be.
You have said that you believe that the market should set the price of stocks. That’s what I believe. That market is not functioning properly so long as investors do not have access to discussions of what the last 43 years of peer-reviewed research teaches us all about how stock investing works. People need to know about the research to make sound decisions. The more people know about the research, the more the market is able to work properly. Denying ourselves knowledge of how the market works is just a negative, it is a wealth-destroyed. New research should be informing market participants about new knowledge.
You’re so worried about what people will do if we let them learn about the research. Let them decide what to do. Let the market work. You don’t need to control it. People can figure out for themselves what to do. A ban on honest posting is an impediment on the market’s ability to work its will.
Rob
“”I believe that, when stocks become more appealing, it may be that low-risk asset classes will need to offer higher returns because their appeal relative to stocks will diminish when the riskiness of stocks diminishes. Is that a bad thing? I see it as a good thing. If that happens, it means that the returns offered by low-risk asset classes were artificially suppressed because people were investing in stocks in irrational ways and thereby pushing the riskiness of stocks higher than it needed to be. ”
And now you seem to think that all assets will magically offer higher returns. The only way that could happen is if most people kept their money under a mattress and only a small minority bought stocks and bonds, meaning that there was no competition driving prices up.
I don’t see anything magical about any of this. When you buy a share of stock, you are buying a share of the productivity of the U.S. economy. It’s not magic that is producing your gains, it’s hard work and creativity.
Irrational exuberance does not come from hard work and creativity. Irrational exuberance comes from investor emotionalism. Investor emotionalism subtracts from wealth. Permitting honest posting re the peer-reviewed research permits us to rein in irrational exuberance and live better lives.
Learning is not magic. It seems like it a bit because it produces such wonderful results. But learning is a realistic way of making life better than what it was before the learning took place.
Rob
“”When you buy a share of stock, you are buying a share of the productivity of the U.S. economy. ”
And my return will depend on how much I paid.
If my share of the economy paid me $5 and I paid $100 I got a 5% return
If someone else out bid me for that share (say $101) they would own it, I wouldn’t, and they would get a 4.95% return on their money.
My 5% would be available to me as long as the other guy didn’t notice and outbid me.
Now according to you if we would just let you post on boards you have been banned at, then the other guy would be content to sit on the sidelines and watch me get the 5% return.
Of course the entire history of people trading shows that you are wrong.
Informed investors set prices better and everyone benefits.
We have never had a fully informed market because we have never before had the research that is now available to us. Shiller’s research is an advance. We should put it to use. It is foolishness to just ignore an advance because there once was a time when it was not available to you.
Rob
Look at who holds the majority of stocks. They don’t need to or want to sell you shares at a cheap price and you can’t force them to sell.
Tell us how you think you are going to educate the current stock holders to sell off their shares for a much lower price versus what they paid.
Look at who holds the majority of stocks. They don’t need to or want to sell you shares at a cheap price and you can’t force them to sell.
I certainly cannot force them. I can explain to them what the last 43 years of peer-reviewed research teaches us all about how stock investing works and give them the option either to accept or reject that message. Many will reject it. I believe that most will reject it at first. But a small number will at least hear me out and some of those will accept the message in part. That number will grow over time. One day we will look up and millions of us will be living better and richer and fuller and freer lives.
It happens through persuasion, not force.
Rob
Tell us how you think you are going to educate the current stock holders to sell off their shares for a much lower price versus what they paid.
My aim is to encourage all investors to act in their self-interest. All investors need to decide on the stock allocation that is best for them. When performing that assessment, they obviously reachable different conclusions if they take irrational exuberance into account. I will encourage them to take irrational exuberance into account.
Rob
“ Many will reject it. I believe that most will reject it at first. But a small number will at least hear me out and some of those will accept the message in part.”
Which means it won’t work. You would need 100% compliance from people to sell their stock at substantial discounts from where it is at today.
How so? Any change is the right direction is a positive.
I don’t personally believe that the Get Rich Quick impulse, which resides within all of us, will ever be entirely removed from the picture. But I am confident that we are capable of doing a lot better than we are doing today.
I believe that, once we open every site to honest posting re the peer-reviewed research, we would be on our way to a situation where the CAPE would always remain somewhere between 14 and 20. That would a far less risky stock market and a far more stable economic system.
Rob