Valuation-Informed Indexing #314
by Rob Bennett
What happens in the economy affects what happens in politics. And what happens in the stock market affects what happens in the economy. So what happens in the stock market affects what happens in politics. It’s all connected.
This year has been a record-breaking year for initial public offerings with companies going public via SPAC mergers, direct listings and standard IPOS. At Techlive this week, Jack Cassel of Nasdaq and A.J. Murphy of Standard Industries joined Willem Marx of The Wall Street Journal and Barron's Group to talk about companies and trends in Read More
We recognize this only to a limited extent in our discussions of economics, political and investing issues. Just about everyone agrees that bad economic times put political incumbents in danger. And most would say that big political developments like the Brexit vote can produce severe economic fallout. But the general inclination is to put investing issues in a box, to act as if the question of how people should go about financing their retirements is a separate matter from how they should go about choosing leaders to run their country or from questions relating to the creation and distribution of wealth.
I think this is a mistake. I believe that Yale Economics Professor Robert Shiller’s “revolutionary” (his word) finding that valuations affect long-term returns suggest a much tighter connection between how we invest and how we govern ourselves and how we create and distribute wealth.
What Shiller showed is that stock prices are often not rooted in reality. They are determined primarily by temporary swings in investor emotion. But of course over time they come to reflect reality; they must if the market is to continue to function. Thus, there are stretches of time when investors earn less from their investments than they expect to earn from them and pull back on spending as a consequence, subtracting trillions of dollars of consumer spending out of the economy and thereby sending it into a tailspin. There are of course political consequences that follow. When millions of workers lose their jobs in a recession, they become dissatisfied with their lives and open their minds to all sorts of ideas that otherwise would be viewed as off the table.
We are living through such times today. When I see Bernie Sanders far exceeding expectations in his challenge to Hillary Clinton for the Democratic nomination for President, I think to myself “this is the insane bull market of the late 1990s coming to roost.” When I see Donald Trump winning the Republican nomination, I think to myself “this is what comes from a string of years in which we all pretended that out portfolios could increase by 15 percent or 20 percent or 25 percent.”
Fake stock gains produce political instability. That’s one of many reasons why I oppose fake stock gains. Everyone would agree if it were not for the non-integrated way in which we think about investing, economic and political issues.
Bad economic times and disruptive political movements trouble all of us. But, when stock prices are rocketing upwards, we take off our political and economic hats and assess things from the perspective of people whose financial futures are being aided. Most people don’t worry about the overvaluation of stocks, figuring that the market will get the price right eventually. It does. But the extreme price drops that are required to recover from the extreme price rises to which we acquiesce cause huge amounts of human misery.
If we were thinking clearly, we would prefer stable stock prices as much as we prefer economic stability and political stability. So long as we can convince ourselves that stock price instability does not cause economic and political instability, we are able to rationalize bull markets as more or less harmless phenomena. Anyway, it’s not our concern. People are today becoming worked up about things they see playing out before us on the political stage and who became worked up in 2008 and 2009 at the economic crisis told themselves that the huge bull market that caused these troubles would have been addressed by the investing experts if it were truly dangerous.
However, there is no group less able to give responsible investing advice than investing experts. Rising stock prices sell investing books and seminars. Rising stock prices make the advisors who encourage the behavior causing prices to rise popular. Rising stock prices make investors heavily invested in stocks happy while making those following more responsible investing strategies appear for a time to be “losers.”
Bull markets are an exercise in investor self-deception. Most of those who come to be viewed as experts in this field during times of high prices are by definition masters of deception. It’s not possible that it could be any other way. If it were possible for those encouraging responsible stock buying to be heard, prices would fall back to reasonable levels and the problem would be vanquished. It is only through the silencing of skeptical voices that a bull market can achieve the runaway status that brings on the economic and political turmoil that began slowly growing in this nation at the bull top of early 2000 and then accelerated in late 2008.
This too shall pass, they say. The greatest bull market of all time will end in tears just as did all those that came before it. But it won’t be just investors who will pay the price of their folly. The false gains of bull markets create false economic good times and political victories that could not be achieved without those artificial economic boosts. And the aftermath of bull markets create unnaturally painful economic times and political riptides that are properly alarming to those living though them and trying to make sense out of things that seem incomprehensible until the massive act of investor self-deception is taken into consideration.
People like bull markets because of the magic trick in which free money is bestowed on them. The reality, of course, is that seemingly free money is the most expensive money there is. In the late 1990s, we elected as a society to move trillions of dollars of future wealth into the current day. In recent years, we have been paying the bill for our imprudence. Those who are feeling the sharpest pains are beginning to speak up because they can see that they were done wrong even though for the most part they still do not appreciate how.
It’s an unfortunate state of affairs to see not just price crashes but crashes in our confidence in our economic system and in our political system taking place at the same time. But it has always been thus. It was a P/E10 level of 33 that brought on the Great Depression and all the political consequences (both good and bad) that followed. This time we took it to 44. We made a decision in the late 1990s to shake things up a few years down the line. Now here we are!
Rob’s bio is here.