Valuation-Informed Indexing #173
by Rob Bennett
I have said many times since the 2008 price crash that we will be seeing another crash that will take us down 65 percent from where stock prices stand today. Nobel-Prize-Winning Economist Robert Shiller, the grandfather of Valuation-Informed Indexing, recently put forward his own prediction of a possible 2014 crash. It’s a comfort to hear someone else making this call. But I have eight problems with the manner in which Shiller advanced his prediction.
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One, I think it was a mistake for Shiller to wait until now to come forward with the prediction. If the crash comes next year, there are many who will say that his prediction was more accurate than mine because he put his forward closer to the day the crash actually occurred. I don’t see it that way.
I think it is a silly game to try to predict crashes with precision. There’s no evidence in the academic research that it is possible to do this successfully So why play the stupid game? What investors need to know is that there is a risk of a crash when prices are too high. Prices have been too high since mid-2009. So the risk has been present for a long time now. And so we should all along have been doing all we could do to make investors aware of the risk.
Two, Shiller suggests with his words that it is bad economic conditions that will serve as the primary cause of the crash. I believe that the causation works just the other way around.
Stock prices crash when large amounts of overvaluation are present. Crashes take huge amounts of wealth out of the economy. The loss of spending power causes an economic contraction. Every secular bear market in U.S. history has brought on an economic crisis. Why not focus on the economic pain caused by bull markets (which are the cause of bear markets) and thereby make the point that we all need to work harder to stop bulls from developing?
Three, Shiller says that “I am not yet sounding the alarm.” I believe that we all should have started sounding the alarm in mid-2009, when valuations shot up from the fair-value levels they achieved in early in 2009 to insanely inflated levels.
We were handed an opportunity to stabilize the economy when prices fell to fair-value levels. If only all of the experts had been careful to sound the alarm when prices began rising and thereby had cut off the risk of another crash before it became too frightening a reality to talk about! The next crash stands a good chance of brining on the Second Great Depression. It is long, long past time to be sounding the alarm!
Four, Shiller focused too much on the negative. There is a big positive side to this story.
Both experts and ordinary investors have for 32 years been reluctant to explore the far-reaching and exciting implications of Shiller’s revolutionary finding that P/E10 levels predict long-term returns. The primary reason has been that they want to go on believing that the gains of the long bull market were real. Once those gains disappear, we will all become able to make a giant leap forward in our understanding of how stock investing works.
Five, Shiller did not specify the size of the crash. We don’t know the precise size. But we know that all earlier secular bears have brought the P/E10 level down to 7 or 8, a 65 percent price drop from where we stand today. We should be telling people that.
Many Buy-and-Holders are today holding on to a fantasy that this bull/bear cycle will bring less pain to investors than any earlier one. Responsible commentators should be doing all they can to throw cold water on fantasy thinking of that sort. It is dangerous.
Six, Shiller did not note the means by which we can minimize the crash. It is true that every earlier secular bear has brought us to P/E10 values of one-half fair value. But there is no law that says we need to go to those insanely low valuation levels this time. We have something working for us this time that we did not have working for us in earlier bear markets — the 32 years of peer-reviewed academic research showing that it is bull market fantasies that cause bear market pain. Why not take advantage of that?
If we told investors not only that a crash is coming but WHY it is coming (because investors have been misled by the Buy-and-Holders into believing that their bull market gains were real), we could keep stock prices from falling below a P/E10 value of 15 or so, the fair-value P/E10 level. Rational investors would not elect to pull prices below fair-value levels. We should be supplying investors with the information they need to adopt a more rational understanding of how stock investing works.
Seven, Shiller suggested that the crash is likely to come in 2014. Perhaps. But the research shows that it is not possible to say WHEN a crash is coming, only that valuation levels are so high that a crash will be coming soon. Guessing when a crash will occur gains one attention when the guess comes through. But it also detracts from one’s credibility when it does not come through.
It is entirely possible that we will see the crash in 2014. But it is also possible that it will be delayed until 2015 or even 2016. Shiller would be on more solid ground in his crash prediction if he made that clear.
Eight, while I believe that Shiller should evidence less certainty re the timing of the crash, I believe that he should evidence more certainty re the fact that a crash is indeed on its way. He says that things “could end badly.” There has never once in U.S. history been a time when we permitted stock prices to rise to today’s levels when things did not end very badly indeed.
I think it would be better to say that things will almost certainly end badly while pointing out that we can mitigate the negative effects by publicizing the breakthrough insights of the past 32 years that we have kept quiet about until now in deference to those who still want to enjoy their dangerous bull-market fantasies.
Rob Bennett has recorded a podcast titled Today’s Understanding of How Stock Investing Works Is Primitive. His bio is here.