Valuation-Informed Indexing #213

by Rob Bennett

Set forth below are a sample of the comments offered by readers of the New York Times article in the awarding of the Nobel prize in Economics to Robert Shiller and Eugene Fama, and my observations on those comments:

AG, from Wilmette, says: “This year’s prize awards two people who reach diametrically opposed conclusions, which in any other empirical science would be regarded as a serious problem.”

I have had numerous Buy-and-Holders tell me that I should not be permitted to challenge the Buy-and-Hold orthodoxy because it is “proven science.” It’s not anything close to that. If Buy-and-Hold were proven science, there would not be Nobel-prize-winning economists publishing research that discredits its fundamental principles. But few big names are willing to speak out against the Buy-and-Hold dogmatism. In my mind, the dogmatism evidences insecurity. When I hear people demanding that all challenges to their thinking be silenced, my spidey sense tells me that the ideas being advanced by these people are likely full of holes.

Sdavidc9, from Cornwall Bridge, Connecticut, says: “If Fama can look directly at a huge bubble and not see it, there is something wrong with the way his mind works and his connection with reality.”

Fama does himself no favors when he says that he does not believe that bubbles exist. Everybody else sees them. However, I have sympathy for the position he finds himself in. If he acknowledges that there are bubbles, the Efficient Market Theory collapses and the Buy-and-Hold investing strategy collapses with it. I look forward to that day. But it will mean a rewriting of all the textbooks in this field. Shiller’s publisher wasn’t kidding around when he described Shiller’s ideas as “revolutionary” on the cover of his book.

Joena Lopez, from Manilla, said: “This prize is an embarrassment. Only in “economics science” can you win a Nobel prize for arriving at diametrically opposite conclusions.”

I don’t object to the diplomacy of giving the prize to both Fama and Shiller. But I believe that the committee that gave the prize should have also called for a national debate on the implications of the research of the two winners. The question of who is right is not an academic one. Our economic system will collapse if it turns out that Shiller is really on to something and yet the big names in this field continue with their relentless promotion of Fama’s ideas. It IS an embarrassment that the economists of today do not yet possess a clear grasp of even the fundamentals of how stock markets work. It is a scandal that they often speak as if they did and that investment advisors do not reveal to their clients how weak the intellectual case is for the dominant model for understanding how stock investing works.

Uziel, from Florianopolis, said: “Hopefully, one day the Committee for the Nobel Prize in Economics will choose to award research done to prevent major financial-economic crises.”

I have spoken to several economists who have expressed a desire to do work of this nature but who have held back because they fear that their careers would be harmed or destroyed if they dared to perform this very important public service. Our reluctance to challenge the Buy-and-Hold dogmatism is killing us. But this is clearly a dying idea and I believe that we will see a change for the better following the next price crash. I sure hope so!

Denis Pombriant, from Boston, says: “One of these views represents a hidebound disinterest in adapting to changing data and circumstances and economists already have a name for it — physics envy.”

Several economics professors have told me that they think things will change following the next price crash, which may put us in the Second Great Depression. At that point the political demand for consideration of new and more realistic ideas re how stock investing works in the real world will be too great for the “experts” to ignore any longer.

John, from Hartford, says: “Fama has done considerable damage to the financial system. That he’s been awarded a Nobel prize for this strikes this reader as perverse.”

My reaction is that it is not entirely fair to put so much blame on Fama. He is a smart fellow who is working hard to generate ideas that help us all figure things out. However, I share this guy’s frustration that so little has been done to correct the conventional advice about how stock investing works in the 33 years since Shiller showed that the fundamental principles on which the dominant model of today (Buy-and-Hold) is rooted have been discredited. Leaders in this field are playing with dynamite, in my assessment.

sdavidc9, from Cornwall Bridge, Connecticut, says: “There is no evidence that economics really wants to be a science. Economists have lucrative consulting contracts they could lose if their science went the wrong way.”

It strikes me as excessively cynical to conclude that financial payoffs are the primary problem. They are a problem, however. And they are a problem with broad political implications. Journalists should be looking into this aspect of the story. There is a Pulitzer waiting to be awarded to the journalist who breaks the story of why the implications of Shiller’s breakthrough insights have been ignored for so many years and at a time when the continued viability of our system of government depends on our getting the word out to millions of middle-class people who are depending on their stock investments to finance their retirements.

sdavidc9, from Cornwall Bridge, Connecticut, said: “James Mill, economist and father of John Stuart Mill, showed that since supply must always equal demand, a general depression was impossible. This was the accepted economics of his day. Fama has done something similar to prove that bubbles are not.”

I love this comment. I have often observed that Buy-and-Hold is perfectly logical as well as perfectly wrong and perfectly dangerous. Economists too often do work aimed at impressing other economists rather than at helping ordinary people invest successfully for the long run.

Ed, from Diurango, Colorado, says: “The main enabler of sizable asset bubbles is keeping the real price histories out of sight. The news media are dominantly supported by paid advertising. News media editorial importantly asks “And what is intellectual honesty’s cash flow?”

Too sad and too true. Will it change now that the game is not working like it once did? If some of us don’t start speaking up, we all go down together.

10) Kanad, from Houston, says: “If they are so intelligent, why couldn’t they come up with any workable solution to this ever-perpetuating economic crisis?”

It’s not hard to come up with a solution to economic crises. Kill bubbles before they grow by getting information out to people showing them how poor the long-term value proposition for stocks is once the P/E10 value goes too much above 20. The trick is getting past the gatekeepers who worry more about not offending any big names than they do about helping the millions of investors who need better information. These people are intelligent enough to get the job done. But there are strong financial incentives for keeping it zipped.

Rob Bennett has recorded a podcast titled What If Everything You Know About Investing Is Wrong? His bio is