Valuation-Informed Indexing #166
By Rob Bennett
Yale Economics Professor Robert Shiller was awarded the Nobel prize in Economics last week.
That’s wonderful news. Shiller is the grandfather of Valuation-Informed Indexing.
I was talking about the ideas explored weekly in this column at the Financial Bloggers Conference in St. Louis (FinCon13) and one of my fellow bloggers told me that this award means that my troubles in trying to spread the word re the implications of Shiller’s findings are over. How can anyone deny the importance of this work now that the Nobel Prize Committee has given Shiller’s research the ultimate validation?
I only wish it were so simple.
I doubt that the award will change much in the short term.
The committee was not saying that Shiller is right.
If they were, they would not have had Shiller share the award with University of Chicago Economics Professor Eugene Fama. If Fama is right in what he says about stock investing, Shiller is wrong. If Shiller is right in what he says about stock investing, Fama is wrong.
Fama made the point very clear in comments of his that were quoted in the New York Times article on the award. Shiller’s life work has been to explore investing bubbles. Fama said that he has never seen a bubble. Fama said that he does not believe that bubbles even exist. Fama did not quite say that Shiller is a fool. But saying that the thing that the man has made the focus of his life’s work does not even exist comes pretty darn close. Fama believes that Shiller is wasting his time and that anyone who explores the implications of Shiller’s findings is wasting his time.
I don’t think it is a bad thing that Fama was awarded the prize. I believe that Fama has been responsible for insights of huge importance. He has obviously had huge influence. And an argument can be made that awarding the prize both to Fama and Shiller is the perfect way to move us away from the dogmatism that has polluted discussion in this field for years now.
By not taking sides, the committee is encouraging people in both camps to try to appreciate the work done by those in the other camp. It’s not realistic to think that we are going to go overnight from a situation where Buy-and-Hold is the dominant school of thought to a situation where Valuation-Informed Indexing is the dominant school of thought. Progress will be achieved gradually over an extended period of time. The joint award sends a signal that dogmatism is not appropriate. That’s a positive message that very much needs to be sent.
That said, it is an exceedingly strange message for a Nobel Prize Committee to be sending.
If Fama is right, the safe withdrawal rate is always 4 percent. If Shiller is right, the safe withdrawal rate varies from a low of 1.6 percent to a high of 9.0 percent.
If Fama is right, stocks are always a good buy for the long term. If Shiller is right, stocks at some prices offer an amazing long-term value proposition and at other prices offer a horrible long-term value proposition.
If Fama is right, it is bad economic times that caused stock prices to fall in 2008. If Shiller is right, it is the fall in stock prices we saw in 2008 that brought on bad economic times.
If Fama is right, investors should generally stay at the same stock allocation at all times. If Shiller is right, investors who fail to change their stock allocations in response to big valuation shifts thereby cause their risk profiles to go wildly out of whack.
It was a diplomatic act to award the prize to both men. It was not a logically consistent act to do so. One of the two men is right about how stock investing works. One of the two men is wrong about how stock investing works.
By having the two men share the award, the committee is implicitly saying that they do not know how stock investing works; they are saying that this is today an open question.
That’s true. It IS an open question.
It is also an amazing and scary reality.
These are the experts. The message being sent here is that the experts don’t know how stock investing works. That’s a message that every single person who has money invested in stocks today needs to hear loud and clear. There are dangers that go with being alive at a time when the experts in this important field do not possess confidence in their understanding of the fundamentals of the field in which they claim expertise.
The award was an honest one. Both men deserve the award for their contributions. And the committee really does not know which of the two will ultimately be proven right. My guess is that they will decide when they see whether we experience another stock crash over the next few years or not.
I understand why they are playing it the way they are. However, I wish they would be more explicit in their acknowledgment of their lack of true expertise. Millions of investors need to know how shaky the case for Buy-and-Hold is today. I know from personal experience that most of today’s investors do not appreciate how little confidence most experts have today re the now-dominant conventional wisdom. I think it is a mistake to keep them in the dark.
I think it is Shiller who is right and Fama who is wrong. One reason I think that is that Shiller did not respond to the announcement of the award in the way Fama did. Shiller did not say that he has never seen an efficient market or that efficient markets do not exist even though his research shows that to be the reality every bit as much as Fama’s research shows what Fama said about bubbles to be a reality.
Fama is the defensive one. Shiller is the one evidencing confidence.