Valuation-Informed Indexing #211
by Rob Bennett
Nobel Prize Winner Eugene Fama said something provocative in an interview he did with the New Yorker some time ago. He said: “We don’t know what causes recessions. We’ve never known. Debates go on to this day about what caused the Great Depression. Economics is not very good at explaining swings in economic activity.”? I know, teacher! Call on me! I know!
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The Great Depression was caused by the popping of the Great Bubble of the 1920s.
How do I know? It’s common sense.
What is the first thing that comes to mind when you think of the Great Depression? It’s the Great Stock Crash of 1929. People’s fortunes being lost. People jumping out of windows. People selling pencils and apples on the street corner. That sort of thing.
Every sensible person connects those two events in his or her mind. It’s only one group of people that doesn’t — Economists. And how sensible are they? Seriously, there is an obvious connection between the two events. The only reason why it is not conventional wisdom that the Great Crash caused the Great Depression is that economists generally have not connected the two.
I have been saying that it was the popping of the stock bubble of the late 1990s that caused the economic crisis that we are struggling through today (which will likely bring on the Second Great Depression if Shiller is right that we have another price crash in our not-too-distant future). The only argument that people who disagree with me have been able to come up with is that that is not what the economists say. But Fama is now spilling the beans and acknowledging that the economists do not know.
So we are free to go with what common sense tells us, no? Common sense says that it was the popping of the stock bubble that caused today’s economic crisis. Stocks were overpriced by $12 trillion in 2000. Shiller’s research shows that prices always return to fair-value levels over the course of 10 years or so. So anyone paying attention should have been expecting $12 trillion of spending power to disappear from our economy sometime near the end of the first decade of the new Century. And here we are.
Why is it that all the economists don’t agree that the stock bubble caused the economic crisis?
Shiller didn’t publish his research showing that long-term return predictions work until 1981. Three decades have passed in real-people time. That’s the blink of an eye in economist time. Economists like to see a new idea proven six times over before they dare to take note of it. My take is that it is dangerous for us to wait too much longer to talk in a serious way about what caused the crisis. So I am willing to go public with my thought that it was the bubble (and the Buy-and-Hold investing strategy that brought it on) that caused the problem.
It’s worth noting that every other economic crisis that we have experienced for as far back in history as we have records of stock prices was preceded by a P/E10 level of 25 or more. And that every time we have seen a P/E10 level of 25 or more, we have seen an economic crisis. The correlation couldn’t be stronger.
The good news is that, if we now know what causes economic crises, we also know how to stop them. We need to stop bull markets. That means that we need to stop telling people that it is okay to stay at the same stock allocation when stock prices go to the moon. If people would give up following Buy-and-Hold strategies, they would sell stocks when the long-term value proposition dropped to unacceptable levels. Those sales would bring prices back to reasonable levels. Stock prices are self-regulating so long as investors are taught the dangers of Buy-and-Hold.
Shiller told a compelling story in the Afterword to the Paperback Edition of Irrational Exuberance. He wrote: “One investment manager for a pension plan spoke to me about how difficult it was for him to suggest in his public statements that people should perhaps be concerned about overpricing of the stock market. Despite his considerable reputation and apparent sympathy with the views expressed in my book, he seemed to be saying that it was not within his authority to make bold and unprovable statements contrary to conventional wisdom. He seemed to view his charge as interpreting received doctrine, and that it would be considered a dereliction of duty to voice contrary opinions that came only from his own judgment.”
I have spoken to economists who have worries about what the continued promotion of Buy-and-Hold strategies is doing to confidence in our economic and political systems but who are afraid to say so publicly. I have spoken to financial advisors who have worries about what the continued promotion of Buy-and-Hold strategies is doing to confidence in our economic and political systems but who are afraid to say so publicly. I have spoken to bloggers who have worries about what the continued promotion of Buy-and-Hold strategies is doing to confidence in our economic and political systems but who are afraid to say so publicly.
Economists help so long as they are not dogmatic about things re which they are not sure. When economists become so dogmatic about things re which they are not sure as to cut off productive discussion, they become a menace. If we do experience the second price crash that Shiller predicts, people from numerous walks of life are going to have to ask themselves whether they have a patriotic duty to raise the questions about the dangers of promoting Buy-and-Hold strategies that too few have dared to ask in recent years.
This isn’t a game.
Rob Bennett has recorded a podcast titled Beyond Doom and Gloom — There’s Gold on the Other Side of the Black Mountain. His bio is here.