Valuation-Informed Indexing #321
by Rob Bennett
I have been following Robert Shiller’s career for many years and I do not recall him being referred to as a “technical analyst.” Yet he is that in a way, is he not?
Lee Ainslie's Maverick Capital had a difficult third quarter, although many hedge funds did. The quarter ended with the S&P 500's worst month since the beginning of the COVID pandemic. Q3 2021 hedge fund letters, conferences and more Maverick fund returns Maverick USA was down 11.6% for the third quarter, bringing its year-to-date return to Read More
Technical analysts believe that market prices follow patterns and that those who become familiar with how the patterns have played out throughout stock market history can thus know in advance how prices are going to change in coming days and profit from it. In short, they believe in timing the market, a cardinal sin in the eyes of fundamental analysts, who believe that it is economic factors alone that dictate market prices and that taking other factors into consideration is superstitious mumbo jumbo.
Shiller is well-respected. He has been awarded a Nobel prize in Economics. I suspect that a big part of the reason why he is not generally referred to as a technical analyst is that those in the dominant school (fundamental analysis is more respected than technical analysis, which is widely but not universally viewed as quirky and non-scientific and “out there” space cadet stuff) respect the man enough to want to avoid insulting him. But that’s not a good intellectual reason for failing to identify Shiller as a technical analyst if that is what he really is. Is that what he really is?
From one way of looking at things, Shiller truly does not engage in technical analysis. You will not find images of teacups and head-and-shoulder patterns and all the other oddities that you see in books advocating technical analysis strategies. An argument could be made that Shiller’s model for understanding how stock investing works is more rooted in economic realities than even the Buy-and-Hold Model. Shiller warn us not to be taken in by the emotionalism that evidences itself during bull markets. Strike investor emotionalism and you are left ONLY with the economic realities, the factors that the fundamental analysts insist should be the investor’s focus.
There is indeed one graphic in Shiller’s book that shows prices forming a pattern. Shiller placed it in the opening pages of the book. He obviously thinks it is important. All of the thousands of words of theory that follow refer back (implicitly, not explicitly) to that opening graphic. The graphic is the objective evidence that Shiller offers that his theory is accurate. All of the arguments that Shiller presents make sense. But the proof that they are on the mark is provided only in the history of stock market prices and that is what is put on display in that opening-pages graphic.
The graphic shows a stock-price pattern. That’s the sort of thing that you see in books on technical analysis. Shiller is sorta, kinda a technical analyst.
The full reality is that Shiller advances an understanding of how stock investing works that combines the best elements of both fundamental analysis and technical analysis while avoiding the weak points of both approaches.
The benefit of fundamental analysis is that it is serious and scientific. It’s hard to imagine that stock prices are determined by some inner need for the market to conform to an odd pattern recognized only by experts in technical analysis. Fundamental analysts say that economic realities rule. Shiller agrees. His P/E10 metric permits us to factor out investor emotionalism and focus in on what matters, the underlying economic realities.
The downside of fundamental analysis is that it is excessively serious and scientific, dogmatically so. It is one thing to say that economic factors are primary and something else entirely to say that investors need not even consider investor emotionalism as it evidences itself in rising valuations. Shiller corrects the error by offering a more balanced take. Avoid short-term timing, he says, in agreement with the fundamental analysts and in disagreement with the technical analysts. But he acknowledges that of course returns are always highly predictable in the long term. How could they not be? To say that long-term timing doesn’t work is to say that price discipline doesn’t work when buying stocks and that claim is an obvious absurdity.
The benefit of technical analysis is that it takes investor emotion into consideration. The odd graphics that fundamental analysts make fun of are said by the technical analysts to be telling a story rooted in the realities of human emotion. Isn’t it at least possible that human emotions play out pursuant to a small number of repeating patterns? If that is so, some form of market timing really should be possible despite the disdain for the concept evidenced by the fundamental analysts. Shiller manages to take investor emotion into account without going so far as to give it a greater role than the economic realities, as a good number of technical analysts do.
The downside of technical analysis is that to focuses so much on investor emotion as to become dogmatic, much in the same way that fundamental analysis focuses so much on economic realities as to become dogmatic. Technical analysts aim to engage in precision-level market timing. They aim to identify the exact days when market turns will take place. It’s one thing to say that prices are highly predictable and something else to say that profits can be consistently earned by jumping through those sorts of hoops. Shiller’s claim is a far more modest one: returns are predictable only in the long-term, after the passage of ten years of time or so.
Shiller is not a technical analyst but he has incorporated one very valuable element of technical analysis into a framework dominated by fundamental analysis considerations and he thereby has developed something new, a balanced model that I believe in time will bring the long ongoing conflict between fundamental analysts and technical analysts to an end by allowing each of the warring camps to come to a better appreciation of the merits of the other fellow’s perspective. Stock returns really are predictable. But only in a limited sort of way. The fundamental analysts have been too complacent in their belief that the things they know are all there is to know and the technical analysts have reached too far too quickly and discredited their genuine contributions by doing so.
Rob’s bio is here.