Valuation-Informed Indexing #101
by Rob Bennett
Buy-and-Hold Investing caused the economic crisis.
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It’s obvious to me. Stocks were overpriced by $12 trillion in 2000. It’s universally accepted that stock prices revert to the mean with the passage of about 10 years of time. So we knew in 2000 that sometime near the end of the first decade of the 21st Century, $12 trillion worth of buying power would disappear from our economy. Hundreds of thousands of businesses would take a big profit hit. Millions of workers would thus lose their jobs. There’s your economic crisis!
Shiller even predicted the economic crisis in his book (published in March 2000). He said: “If over some interval in the first decade or so of the 21st Century the U.S. stock market is going to follow an uneven course down as well it might — back, let us say, to its levels in the mid-1990s or even lower — then individuals, foundations, college endowments and other beneficiaries of the market are going to find themselves poorer, in the aggregate by trillions of dollars. The real losses could be comparable to the total destruction of all the schools in the country, or all the farms in the country, or possibly even all the homes in the country.” That sure sounds like an economic crisis to me!
So why am I the only one saying this? Why are so many of us trying so hard to avoid acknowledging what is so obviously the true cause of the crisis?
There are eight reasons:
1) We are ashamed.
We all played a part in causing this crisis. Even those of us who refused to buy stocks at insanely high prices failed to speak up against the bull market in clear and firm and bold terms. We are not idiots. We knew the crazy bull prices couldn’t be real. Now we look at the human misery we have caused and want to kick ourselves. The last thing we want to do is to examine the role we played in bringing on this mess;
2) Our minds are in a fog.
We always knew on some level of consciousness that the bull was a terrible mistake. But Behavioral Finance is a new school of thought. So most of us don’t know the details of how bulls come into being and of how they cause huge human wreckage each time they do. We kinda sorta know that there are problems with Buy-and-Hold. But our understanding is dim. We won’t put confidence in the idea that Buy-and-Hold caused the crisis until we are better educated about these matters;
3) We have political agendas.
Within 24 hours of the arrival of the crisis the Democrats had figured out how it was the Republicans’ fault. And the Republicans had figured out how it was the Democrats’ fault. It’s hard for any of us to resist the temptation to score cheap political points. So we direct our mental energies not to understanding what brought on the crisis but to positioning our team for gains on the scoreboard;
4) We’re looking for economic explanations.
We don’t think of the functioning of the stock market as an economic concern. It is that. When the market becomes dysfunctional, the economy soon becomes dysfunctional. It’s happened four times in U.S. history and there has never yet been a time in which it happened any other way (that is, every huge bull market was followed by an economic crisis and every economic crisis was preceded by a huge bull market). But we think of the market being affected by economic developments rather than bringing them on;
5) We allow ourselves to become distracted by short-term factors.
It is the price levels that applied in the late 1990s that caused the economic crisis that began in late 2008. That’s a counter-intuitive reality. Our inclination is to imagine that a problem of the late 1990s should have caused bad results in the late 1990s. The reality is that it takes years for the lack of confidence in the future that is brought on by a bull market (we lose confidence in the future because we understand on some level of consciousness that the phony bull-market gains will soon disappear) to produce bad effects. It will take some time for that reality to sink in;
6) We underestimate the size of the problem.
A crisis of this magnitude creates for a society the sort of emotional hit felt by an individual when he learns he has cancer. We’ve got to work through the denial and anger and compromise stages of the grief process before we can come to acceptance of the realities. Many of us are still pretending that this is going to go down in history as run-of-the-mill recession. If that were so, we wouldn’t need to come to terms with the true cause of the crisis. We are hesitant to put ourselves through the emotional pain connected with doing so, hoping it will all go away without our needing to do so;
7) The Stock-Selling Industry has zero interest in filling us in.
There was lots of money to be made pushing Buy-and-Hold for a good number of years there. All of the “experts” who promoted this strategy are now potentially on the hook for large legal liabilities (Shiller published his research showing that valuations affect long-term returns in 1981). So the people we turn to to tell us about stock investing have kept mum on any suspicions they have as to the true cause of the economic crisis; and
8) We don’t yet appreciate that identifying the true cause of the crisis would put us on the road to overcoming it.
Once we acknowledge its true cause, the crisis will be well on its way to being over. The worst part of the price contraction we see in the wake of every huge bull is not the return to fair-value prices. The worst part is the drop to price levels of one-half fair value. Those come because of the economic troubles brought on by the drop to fair value prices. The cool thing is that we can avoid the drop to price levels below fair value by educating people as to the true cause of the crisis; once people understand that there is nothing fundamentally wrong with the economy and we just need to be sure never again to follow Buy-and-Hold strategies to prevent this sort of thing happening again, we will all feel renewed hopes for the future and begin again spending what we need to spend to get the economy back on its feet. As of today, though, things have not gotten bad enough for policymakers to dare to give voice to that important message.
Rob Bennett has written about what it takes to become an intelligent investor. His bio is here.