I’ve posted Entry #400 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Shiller Should Return to Making Long-Term Predictions.

Juicy Excerpt: One, it is the fair thing to do. Our Buy-and-Hold friends do not believe that predictions work. Shiller’s research suggests that they should. The Buy-and-Holders are right to seek accountability from those of us speaking from the other side of the table. If we truly believe that Valuation-Informed Indexing is a better strategy, we should demonstrate the courage of our convictions needed to put our names on publicly voiced return predictions. When those predictions fail, it helps the Buy-and-Hold case. And it should. If effective predictions cannot be made, Buy-and-Hold is the best strategy and investors need to know that.

Two, the humbling experience of seeing a prediction fail forces those of us who believe that at least long-term return predictions should be possible back to the drawing board. Shiller got it wrong back in 1996. I got it wrong when I made my prediction after the price recovery of March 2009. As painful as it is to make public mistakes, doing so can bring on a learning experience if we dig deep to discover why we got it wrong. None of us today knows all there is to know about how stock investing works. We all need to be digging deeper all the time. We possess a human inclination to become complacent in our beliefs. Seeing those beliefs fail a public test shakes us out of our complacency.

I’ve posted Entry #399 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Shiller’s Ideas About Stock Investing Haven’t Caught On Because They Represent Too Big an Advance.

Juicy Excerpt: I believe that evolution instilled in human beings a strong reluctance to break with the herd. Those who were separated from the herd lost the protections that follow from traveling with a herd and were killed by predators. We are followers. We check our tentative beliefs with others and, when others approve of them, we gain confidence in them. When others react in violently negative ways to our tentative beliefs, we reconsider. We put serious effort into the project of reconfiguring our beliefs to bring them back into accord with what our fellows signal to us is acceptable.

I’ve posted Entry #398 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Putting More Focus on Valuations Would Make Indexing More Popular.

Juicy Excerpt: What happens when stock prices rise so high as to bring on a crash? People lose money, of course But it’s not just that. When people lose large portions of their life savings in a crash, they lose confidence in the stock asset class itself. Most people don’t understand that it is only when stocks are high-priced that they become dangerous. People who suffer through a crash swear off the asset class and become reluctant to invest in stocks even when they are selling at perfectly reasonable prices. These investors lose at both ends. They see large portions of their life savings disappear because they buy into the hoopla about stocks when they are dangerous and then they miss out on the benefits of stocks when the dangers are close to nonexistent.

I’ve posted Entry #397 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called If Shiller Is Right, Today’s Investors Should Be Highly Emotional.

Juicy Excerpt: Stocks are today priced at more than two times fair value. If Shiller is right, that’s because today’s investors are irrationally exuberant about their stock holdings. Could they maintain their irrationality if they were regularly exposed to the other point of view? We are experiencing a Catch-22. For Buy-and-Holders to be willing to listen to criticisms of their strategy, they would need to be rational enough to permit the voicing of other points of view. But if they were today capable of that level of rationality, we wouldn’t have the high prices that have made Buy-and-Hold so dangerous in the first place.

Buy-and-Hold is popular because prices are high. It’s the irrationality of the strategy that is the source of its appeal! Irrational investors will not permit themselves to be exposed to rational critiques of their investing beliefs. Shiller’s message is common sense. If Buy-and-Holders were open to hearing him, they would not have needed him to make the arguments, they would have come up with them themselves. It’s all a circle.

I’ve posted Entry #396 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Would You Prefer to See Stock Prices Double or Drop by 50 Percent Over the Next 12 Months?

Juicy Excerpt: The problem that I have with the idea of taking joy in price increases is that there is no end to it. If it would be a good thing for prices to double, wouldn’t it be an even better thing for prices to triple? Or to quadruple? There is no point at which the logic employed by Buy-and-Holders would ever reject a price increase as being just too darn big. In the Buy-and-Hold world, the market is rational. That is the core assumption. If the market decides that it is proper for prices to quadruple, then it is proper for prices to quadruple. The market is all wise. The market decides.

We are the market. That’s my concern. We are emotional creatures. It seems entirely possible to me that we could decide to increase stock prices to a point at which further increases are no longer in our best interest. And with no way to recognize the point at which further price increases become a negative, we would just keep stepping on the gas as things got more and more out of control.

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.

I’ve posted Entry #394 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Buy-and-Hold Is Both Consistent With Common Sense and Inconsistent With It.

Juicy Excerpt: I don’t believe that Buy-and-Hold is common sense. But I believe that the reason why the Buy-and-Hold strategy possesses so much appeal to so many investors is that on first impression it appears to be rooted in common sense. I was once a Buy-and-Holder myself. I know that for me it was the impression that Buy-and-Hold is the common-sense investing strategy that won the day for it.

I’ve posted Entry #393 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called To Say That Stock Prices Are Determined by Emotions Is Not to Say That Economic Developments Don’t Matter.

Juicy Excerpt: Market prices recovered quickly in the wake of the 911 attacks. Could it be that that’s because the underlying emotional mood of investors at the time was strong enough to permit emotions to swing quickly from a negative place to a positive place? What if the terrorist attacks had taken place in late 2008 or in early 2009, when investors were in an emotionally sensitive place? Would the losses resulting from the attacks have been deeper? Would they have lasted longer? Would there have been any recovery to pre-attack prices at all in those circumstances?

I believe that it is investor emotion that is the primary driver of stock price changes. It doesn’t follow that I believe that economic developments play no role. Economic developments affect investor psychology. So those of us who believe that investor emotion is the primary driver believe that economic developments are important. Our difference with the Buy-and-Holders is that, while we believe that economic developments are important and unpredictable, we do not believe that price changes are entirely unpredictable. The potential for big and lasting price drops is far greater at times when valuations are high because high valuations instill worry in investors that prices will be falling hard at some point in the future and that causes them to react differently to bad economic developments than they would at times when stocks were reasonably priced.

I’ve posted Entry #392 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Shiller in 1996: “Long-Run Investors Should Stay Out of the Market for the Next Decade.”

Juicy Excerpt: Shiller states: “Looking at the diagram, it is hard to come away without a feeling that the market is quite likely to decline substantially in value over the succeeding ten years; it appears that long run investors should stay out of the market for the next decade. Is this conclusion right? How can we reconcile it with the widespread public impression that the random walk hypothesis is at least approximately true?”

I’ve posted Entry #391 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Fama Gave Us a Powerful Engine in a Good-Looking Car, Shiller Provided the Brakes.

Juicy Excerpt: In other markets, there are natural limits on how high prices can go. The people who sell us sweaters and bananas and batteries would love to see the prices charged for those items go up and up and up. But the reality is that if any seller of sweaters or bananas or batteries gives in to the temptation to charge a very high price, he will soon find himself out of business. In other markets, there are always pressures pulling prices down to counter the pressures pulling prices up. In other markets prices are set through a battle between the sellers who want them to rise as high as possible and the buyers who want them to drop as low as possible.

It doesn’t work that way in the stock market. In the stock market, buyers love, love, love high prices. When stock prices go up, we all pay more for the shares we buy each month. But we tend not to focus on that side of the story. We are happy to pay higher prices for the new shares we purchase because it means that the shares that we have held for a long time are priced higher too. The stock market is the only market that I can think of in which both buyers and sellers possess the psychology of sellers. Both buyers and sellers like to see prices headed up, up, and up some more. There is no natural resistance to higher prices in the stock market.