I’ve posted Entry #207 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Rational and Irrational Investing Ideas Co-Exist.

Juicy Excerpt: People don’t respond with excitement when they learn that it is possible to reduce stock investing risk by 70 percent. They respond with worry. What if it doesn’t work? It’s been working for 140 years. What if you got something wrong? The paper passed peer-review and is subject to challenge to anyone who has access to the internet. What if it stops working? Anything can happen in this crazy, mixed-up world of ours but most of us elect to get out of bed every morning and brush our teeth and get on with the business of the scary new day all the same.

There’s something about stock investing that makes people think it should be rational. There’s money involved. I think that’s the thing. Bankers don’t wear loud ties because folks who appreciate formality in every other life endeavor sleep better knowing that their retirement money is being handled by people of great prudence. We don’t want the people handling our money to be wild and crazy guys and gals. So we like to think that there is some magical force rendering the stock market a rational place.

It’s not so.

The market is every bit as rational and every bit as nutso as the humans who participate in it. That’s us! The market is no more serious or silly than all of us who have money in it.

I’ve posted Entry #206  to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called When We Say That the Market Is Smart, We Are Flattering Ourselves.

Juicy Excerpt: The market is comprised of people who own stocks. The market is us. When we argue that the market is smart, we are flattering ourselves.

The only way that the market could be smarter than the rest of us is if the people who comprise the market were smarter than the rest of us. Rich people own more stocks than people who possess low or moderate amounts of wealth. So, if you believe that rich people are smarter than people of low or moderate wealth, it would not be unreasonable to believe that the market is smarter than the rest of us.

But you don’t often hear people saying “rich people think inflation is headed upward” to support their arguments. The idea behind claims that the market believes something is that there is some ruthless truth-telling quality about markets that make their beliefs especially credible. I don’t see it. Markets are comprised of people and people get some right and some wrong regardless of whether they participate in markets.

I’ve posted Entry #205 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called An Easy and Convincing Way to Reconcile the Ideas of Shiller and Fama.

Juicy Excerpt: There are two possible explanations for why short-term timing does not work.

One is the one that Fama advanced. It could be that the market is efficient. That is, that all information bits affecting price are immediately incorporated into market prices. If this were so, all of the principles of the Buy-and-Hold Model (the model for understanding how stock investing works built on Fama’s research) would follow.

The other possible explanation is that the market is in the short term the farthest thing from efficient that is possible. If it were investor emotions that determine prices in the short term rather than economic realities and if economic realities became the dominant influence on prices only in the long term, short-term timing would not work. Emotions are irrational. Things that are irrational are unpredictable.

There’s a way to determine which of the two explanations is the right one. If the reason why short-term timing doesn’t work is that the market is efficient, long-term timing would not work either. But if the reason why short-term timing does not work is that it is investor emotions that determine short-term prices, then long-term timing would work.

I’ve posted Entry #204 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called What Economists Say About Shiller’s Nobel Prize.

Juicy Excerpt: “We have big important questions that remain largely open and we have giants bringing evidence to bear. And the answer turns out to be more complicated than markets are efficient — or markets are inefficient.”

Yes. The toughie is — How can both Fama and Shiller be right? My take is that Fama is right that the market longs to be efficient and would be efficient if only investors had access to the information and tools needed for them to exercise price discipline when buying stocks (as they do when buying all the other goods and services offered in every type of market other than the stock market). Fama’s tragic mistake was jumping to the conclusion that the reason why short-term timing doesn’t work is that prices are set rationally — The real reason is that it is investor emotion that determines prices in the short term and emotion is unpredictable stuff.

Add Shiller’s insight (that prices are determined by emotion in the short term) to Fama’s (that the market must get the price right eventually because that is what markets do) and you’ve really got something. We don’t need to reject Fama’s insights, we need to look at them in a new light informed by Shiller’s insights. Both “sides” have something powerful to contribute.

If only the Buy-and-Holders could calm down enough to see that acceptance of Shiller’s contribution brings them to the place that deep in their hearts they really want to be.

I’ve posted Entry #203 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Would P/E12 oe P/E8 Work As Well as P/E10?

Juicy Excerpt: The other side of the story, however, is that a less productive economy will hurt Buy-and-Holders as well. And Buy-and-Holders too will be underinvested in stocks in the event that we see levels of productivity that few anticipate. The reality that the U.S. economy may be more or less productive in the future than it has ever been in the past is not an argument for staying at the same stock allocation at all times so much as it is an argument for being flexible in one’s expectations of future returns.

I’ve posted Entry #266 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called How a Visit to the Dentist Is Like a Visit to an Investing Analyst.

Juicy Excerpt: I was sitting there getting my teeth cleaned and feeling guilty about how long I had put it off when it hit me — “This is just like investing!” It’s all emotion. There have been a lot of advances in dentistry in recent decades. There is a lot of technology that can be put to use to help us keep our teeth in good repair longer than was possible for our parents. But our dentists get frustrated because a lot of us don’t listen to the simple instructions they give us that could save us so much discomfort down the line if we would just take them to heart. Why don’t we listen?

I’ve posted Entry #202 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Jeremy Siegel’s Views on Where Stock Prices Are Headed Are Not Rooted in Peer-Reviewed Research.

Juicy Excerpt: If Fama is right, stocks can never be underpriced any more than they can ever be overpriced. Stocks are always properly priced in an efficient market. The price that applies when all factors bearing on price are taken into consideration is obviously the proper price.

So how can any academic argue that stocks are underpriced?

An individual investor can do that. There are obviously lots of individual investors who do that all the time. But Siegel is not being quoted at web sites because everyone wants to know his views as an individual investor. He is being quoted because he is an academic, he is presumed to possess a special understanding that makes his views more important than the views of ordinary investors.

But the view that Siegel is putting forward here is not rooted in either of the two academic models! The idea that stocks are underpriced makes no sense under the Shiller model. And the idea that stocks are underpriced makes no sense under the Fama model. The idea that stocks are underpriced makes no sense under either of the two academic models. And yet Siegel, a well-known academic, gives voice to that view and is quoted in the media for doing so as if his views possessed some special significance because he speaks with the authority of a well-informed academic.

I’ve posted Entry #201 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Shiller Doesn’t Dare Say What He Believes Is the True Cause of the Economic Crisis.

Juicy Excerpts: Samuelson hints at the true cause of the crisis without quite becoming so bold as to identify it bluntly.

He tells us: “We were victims of success. The crisis originated from 25 years of prosperity, from roughly the end of 1982 to the end of 2007. This conditioned people — bankers, regulators, economists, almost everyone — to take stable growth for granted. The longer the prosperity continued, the more it inspired the risky behaviors that ultimately wrecked the economy. These included over-borrowing by consumers and financial institutions, housing speculation and loose regulation. The ‘causes’ cited by left and right were usually the consequences of a delusional mind-set: a belief that once-risky practices were prudent in a world of near-perpetual prosperity.”??It all began in 1982, huh? I wonder if there was anything relating to the stock market that began in 1982? I have a feeling that that might be the case. The words are on the tip of my tongue. I just cannot quite bring the thought to mind.

That phrase “delusional mind-set” might be a clue. It reminds me of a similar phrase. Irrational Something or Other. Again, I just don’t seem to be able to pin it down. Some sort of unease about saying the words out loud is holding me back.

I”ve posted Entry #200 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Moving Stock Returns From One Time-Period to Another Reduces Economic Productivity.

Juicy Excerpt: People complain all the time about our low savings rate. Bull markets contribute to that. Buy-and-Hold contributes to that.

 

People save when they are motivated to save. During a bull market, people look at the 30 percent gains they are seeing on their stock portfolios and determine that they don’t really need to buckle down just yet. It’s not irrational behavior. Stocks were priced at three times fair value in 2000. So an investor who had $200,000 of real value in his stock portfolio was led to believe that he had $600,000 of real value in his stock portfolio. It should shock no one that someone who thinks he is $400,000 farther along in his effort to finance his retirement would ease up on saving efforts for a time.

 

I’ve posted Entry #199 to my weekly Valuation-Informed Indexing column at the Value Walk site. it’s called Investing Strategies That Ignore the Effects of Stock Crashes Cannot Work.

Juicy Excerpt: You really only need to know one thing about stock market history to know that the market is not efficient. Prices crash from time to time. If prices were determined by economic realities, there would be ups and downs in prices. But there would never be crashes. The market lost over $9 trillion in value in the 2008 crash. There is zero chance that informed investors had in late 2008 taken note of changes in the economic realities serious enough to justify that sort of change. The market crashed because market prices are determined primarily by shifts in investor emotions and one of the characteristics of emotions is that they change suddenly and harshly.

Emotions are not rooted in logic. So they can do just about any crazy thing. It is critical that those studying stock investing come to a better appreciation of this seemingly obvious implication of Shiller’s “revolutionary” (his word) finding. When I tell people that the numbers show that it was the relentless promotion of Buy-and-Hold strategies that served as the primary cause of the economic crisis, they find it a hard reality to take in.

It doesn’t make sense! Surely investors would not let prices get so out of hand as to cause $12 trillion of consumer buying power to disappear from the economy as prices worked their way back to fair-value levels. No, it doesn’t make sense. But bull markets aren’t supposed to make sense. They are an emotional phenomenon, not a rational one. What would make sense is for the P/E10 always to remain at 15, the fair-value P/E10 number. Higher P/E10 values signify the presence of unhealthy levels of investor emotion and we need to pay attention to those readings if we are to invest effectively for the long-term and to avoid the sorts of economic crises that have followed every secular bull market experienced over the 140 years of stock market history available to us today.

So long as stock market prices are determined by emotional phenomena, we are going to see terrifying price crashes and the terrifying economic crises that inevitably follow from them. The other and more positive way of stating it is that, now that we are aware that market prices are determined by emotional phenomena, we are empowered to avoid crashes and economic crises by educating investors as to how they need to respond to bull-market prices to win higher lifetime returns and earlier retirements for themselves.