Valuation-Informed Indexing #329
by Rob Bennett
Those of us who believe in free markets should be ashamed of stock crashes.
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
Most stock investors are not gambling or playing a game. They are financing their retirements. Investing is a serious business. Stock crashes are terribly painful events. But they are not serious events. They are the product of investor and investment advisor foolishness.
No good explanation has ever been put forward for why stock prices crash. It would make sense for prices to change a bit from day to day. It does not make sense for trillions of dollars of wealth to disappear into thin air over the course of a few days or a few weeks. After every crash, investors whose lives have been destroyed ask: “Where did the money go?” It is an excellent question. Those who to this day promote Buy-and-Hold strategies are not able to offer satisfying answers. There aren’t any.
It should not be possible for that much money to go “poof!” in so short an amount of time. Common sense tells us that serious things possess lasting value. Stock crashes signal to millions of people that the stock market is not a serious thing. That message undermines confidence in our economic system and even in our political system. Middle-class people need to be able to count on the money they have put aside for their retirements remaining in place for some time. Small ups and downs are of course to be expected. Crashes that cause the loss of half of a person’s accumulated wealth of a lifetime are not acceptable.
Look at what happened as a result of the biggest crash seen to date in the United States. The crash of 1929 brought on the Great Depression. Capitalism survived. But just barely. Millions of people lost confidence in our economic system as a result of that crash. Rightly so. It is just not possible for people to believe in something that produces such arbitrary results, delivering gains all out of proportion to the economic growth generated by the underlying companies for many years in a row and then delivering losses all out of proportion to the economic losses generated by the underlying companies for many years in a row. The story being told by a stock market that falls into crash mode every 35 years or so is not a believable story.
Many theories have been put forward by people trying to explain November’s election results. I believe that many of the factors that fascinate political insiders don’t have much impact on ordinary people. I believe that the political unrest that we are seeing today both on the right and on the left is the result of the 2008 economic crisis. People saw a collapse and they did not hear a reasonable and clear explanation of what was behind it. They saw that no one was held accountable for the collapse. They sense that they have been conned. They are right (although not quite in the way that they imagine).
I once wrote the owner of a conservative blog to ask whether he would run a guest blog entry that I wrote pointing out the dangers of Buy-and-Hold and how the huge price run-up it caused brought on the crisis. He rejected the article without taking issue with the points made in it. His complaint was that the problem that I was describing was not something that was caused by the government. The thinking seemed to be that government is the enemy of conservatives and that thus articles that don’t find fault with government aren’t relevant to conservative readers.
I have a different perspective. I am a conservative (with sympathies for a good number of liberal positions). One of the things that makes me a conservative is my love for free markets. So I naturally want to see our free market work. I don’t like stock crashes because they send a message to millions that they don’t.
And I think it is largely futile to try to convince people who have recently lived though a stock crash that free markets work. People are more influenced by personal experiences than they are by ideological arguments. When stock prices crash and people see their lives ruined, they look for something to blame. The obvious place to direct the blame for a stock crash is with the people who argue for the free markets in which stock crashes take place. Crashes undercut all of the many otherwise good arguments that conservatives make for free markets in the minds of millions of people.
Robert Shiller talked about how the promotion of Buy-and-Hold strategies causes price crashes in his best-selling book Irrational Exuberance. He wrote: “If over some interval in the first decade or so of the twenty-first century the U.S. stock market is going to follow an uneven course down, as well it might — back, let us say, to its levels in the mid-1990s or even lower — then individuals, foundations, college endowments, and other beneficiaries of the market are going to find themselves poorer, in the aggregate by trillions of dollars. The real losses could be comparable to the total destruction of all the schools in the country, or all the farms in the country, or possibly even all the homes in the country.”
Those of us who love free markets should be ashamed that we haven’t done more to warn people of the dangers of Buy-and-Hold strategies in the years since publication of Irrational Exuberance. If our love were true, we would do more to stop the overvaluation that causes crashes from getting out of hand.
Rob’s bio is here.