Valuation-Informed Indexing #239
by Rob Bennett
I am often asked whether I believe that the unwillingness that many of us feel to discuss the implications of Yale Economics Professor Robert Shiller’s 1981 finding that valuations affect long-term returns is the result of a “conspiracy” to keep these “revolutionary” (Shiller’s word) findings covered up.
My answer is — yes and no.
There is obviously not a conspiracy in the sense that the word is usually employed. There are not men and women who met in smoke-filled rooms to construct a plan by which they would deceive us about the realities of stock investing.
Still, the realities here are exceedingly odd. Shiller showed that stock investing risk is not constant but variable. It is possible today to develop tools that would permit investors to reduce the risk of stock investing by 70 percent just by showing them the extent to which they need to adjust their stock allocations in response to valuation shifts to keep their risk profiles roughly constant. Experts could make millions developing and promoting and selling such tools. Why have they let the opportunity pass them by?
There is no conspiracy in a direct sense. But there is a fluid sort of conspiracy that might be referred to as a “Conspiracy of Ignorance.” There are lots of people who don’t want to understand the implications of Shiller’s findings and who through various means discourage those who would otherwise help us all to understand to keep quiet about what they know. There is a powerful social stigma that keeps people who in other circumstances would be happy to teach us about the dangers of Buy-and-Hold strategies from doing so.
Shiller’s research findings make bull markets impossible. Once investors come to appreciate why bull markets are so harmful to all stock investors, we will not see any more of them. Stock prices are self-regulating in a world in which information about what the last 34 years of peer-reviewed research says can be openly shared.
But we love bull markets!
Bull markets are perceived as great times. The economy booms in bull markets. Retirement accounts get bigger at a fast pace during bull markets. People buy books about investing during bull markets. People consult investing advisors during bull markets. People visit investing web sites during bull markets. People re-elect politicians who serve during bull markets (because they like the economic booms that take place during them).
There’s no one who doesn’t profit from a bull market.
Wait. That’s not so. We all are hurt by bull markets. None of us know the true value of our portfolios during bull markets. So effective financial planning becomes an impossibility. We borrow trillions of dollars worth of economic growth from future days during bull markets and that causes economic recessions. Bull markets cause bear markets, which make it hard for us to get good returns on our money for long periods of time. Bull markets are a pain.
But they do not seem to be a pain at the time they are taking place. Bull markets seem wonderful.
And of course we all possess the common sense needed to recognize that bull markets are in a long-term sense not nearly as wonderful as they seem. So many of us are tempted to speak the words that would bring the bull market to an end before it gets out of control.
It’s that combination of inclinations that makes the social pressure not to spoil the bull market so intense. If we didn’t enjoy bull markets so much, we would permit people to say whatever they pleased about them. And, if the case against bull markets was not so compelling, it wouldn’t bother us for people to speak against them because nothing they said would worry us. But when you are trying hard to believe in something that is pretty darn unbelievable to anyone with a reasonable amount of common sense, the only way to pull it off is to impose strict limits on what can be said about that something.
So there is a sense in which there really is a conspiracy keeping us from knowing the truth about stock investing. It is not a conspiracy of investing advisors or a conspiracy of journalists or a conspiracy of economists or a conspiracy of policymakers. It is a conspiracy of all humans. We all want bull markets to continue when they are going on. And we all worry that permitting the case against bull markets to be spoken aloud will ruin them. So we all participate in the conspiracy to silence criticism of bull markets.
But will be still do that following the next crash?
I don’t think we will. We did not have the peer-reviewed research we needed to understand how stock investing works when earlier bull markets came to an end. So we eventually returned to the bad behavior that creates them.
This time we have 34 years of peer-reviewed research plus whatever additional work is done before the current bubble busts showing us why it was a mistake to let stock prices get so out of hand. I believe that the failure of this bull market is going to produce a very different reaction than we have seen follow from the failure of any of the earlier ones.
I believe that the Conspiracy of Ignorance is close to coming to a permanent stop.
Please don’t tell anyone that I said that until it happens. I don’t want to be known as one of those people who talks out of turn re this sort of thing!
Rob Bennett recorded a podcast titled My Great Crime — I Predicted the Stock Crash 12 Years Too Soon. His bio is here.