Valuation-Informed Indexing #192
by Rob Bennett
The Brad Delong blog recently published extensive text from an interview that Yale Economics Professor Robert Shiller did with PBS on his recent award of the Nobel Prize in Economics. As is always the case with Shiller interviews, the PBS interview is filled with insights. However, I also believe that there are several cases in which Shiller made questionable or unfortunate statements.
Bonhoeffer Fund's performance update for the month ended July 31, 2022. Q2 2022 hedge fund letters, conferences and more The Bonhoeffer Fund returned 3.5% net of fees in July, for a year-to-date return of -15.8%. Bonhoeffer Fund, LP, is a value-oriented private investment partnership for . . . SORRY! This content is exclusively for Read More
Shiller sums up the Valuation-Informed Indexing difference well when he says that: “The whole idea that the stock market reflects fundamentals is, I think, wrong. It really reflects psychology. The aggregate stock market reflects psychology more than fundamentals. This is where maybe I really do differ from Gene Fama. I don’t think he would say that.”
That changes everything. If stock prices are determined primarily by investor emotions and if we have a metric (P/E10) that permits us to assess how emotional investors are at any given point in time, we have a means to predict long-term stock prices. Once stock prices become predictable, timing becomes not just a good idea but a requirement of those hoping to have a realistic chance of long-term investing success. If we can tell in advance how risky stocks are, we must be sure to lower our stock allocations when risk increases or else permit our risk profiles to go wildly out of whack.
So I love that statement. With one caveat. Shiller is an extremely nice guy. It comes through in every interview I have seen. He is genial and has a generous, non-arrogant spirit and makes a serious effort to see where the other guy is coming from. Which is all wonderful. He just takes it too darn far on occasion! When he says that Fama might not agree that stock prices are determined by investor psychology rather than by economic fundamentals, he is understating the point to a comical extent. Fama would have popped a blood vessel if he had been sitting in the studio next to Shiller when he made that statement.
There is a horrible statement made in a Business Insider report on the interview that is not entirely (but perhaps partly) Shiller’s fault. The Business Insider article states that: “Shiller reminds us that the CAPE model is not good for timing the market, a point he’s reiterated in the past repeatedly.” Yes and no. Shiller has of course on many occasions made the point that short-term timing does not work. But he has of course never said the same of long-term timing, which has been wo