It is my view that the most important book ever published on how stock investing works is Robert Shiller’s Irrational Exuberance. But —
It only tells half of the story.
Q1 hedge fund letters, conference, scoops etc
Please consider the title. It should shock you. Shiller’s book argues that much of our stock wealth is phony wealth. Is that not what the phrase “Irrational Exuberance” suggests? The conventional (Buy-and-Hold) view is that stock price changes are caused by economic developments. So they are real. You can count on them to finance your retirement. Shiller is saying something different. He is saying that they are rooted in emotion, that to the extent that the numbers on our stock portfolios are larger than what they would be if stocks were priced at fair-value levels, they are temporary and cannot be counted on to finance a retirement.
But he never actually says those words. He makes a compelling case for his belief that inflated stock prices do not possess lasting significance. But he never spells out how dangerous a situation it is that the vast majority of investors still possess confidence in the Buy-and-Hold Model.
Shiller could be wrong. He is one of those darned humans, who have been getting it wrong ever since time began. But what if he is right? If he is right, we are in a whole big heap of trouble.
If Shiller is right, the numbers that millions of us have used to finance our retirements are wildly off the mark.
If Shiller is right, the return assumptions that pension funds have been using to insure future payouts make no sense.
If Shiller is right, the economic crisis that began in late 2008 will soon be entering a darker and scarier stage which will cause tens of thousands of businesses to fail and millions of workers to lose their jobs.
If Shiller is right, we need to rewrite all of the textbooks in this field so that we can teach newcomers how things work according to the most recent research instead of according to the research that existed prior to Shiller’s arrival on the scene.
If Shiller is right, we should be teaching investors to exercise price discipline when buying stocks so that bull markets never get too out of hand, which is the opposite of what we tell them today, that it is not necessary or that it might even be a bad idea to time the market.
If Shiller is right…. I could go on and on. There are thousands of things. Shiller’s challenge to Buy-and-Hold was a fundamental challenge. Buy-and-Holders believe that price changes are rooted in economic realities. Shiller believes that they are rooted in passing emotional moods. That changes everything.
Why didn’t Shiller spell it all out?
I think it is because his research findings are so important. If he had found some little error in the Buy-and-Hold Model, he could point it out and the Buy-and-Holders would thank him for doing so and get about the business of making the necessary correction. But he didn’t find some little error, he found that the core assumption of the model (investor rationality) is in error. He found that they got it all wrong. That’s a lot harder to acknowledge. Shiller would have taken on a lot of heat if he had stated in clear and simple terms all that the Buy-and-Holders got wrong.
Still, we (I include my Buy-and-Hold friends in the “we”) want to get this investing stuff right. If Shiller is right, we are going to have to get about the business of making those corrections. We can’t do that until we know that they are needed. We need clear and simple statements as to the many far-reaching implications of Shiller’s research findings to get the ball rolling.
The Buy-and-Holders really don’t believe that they got it wrong. They believe in their strategy. They follow it themselves. The idea that they got it all wrong is beyond the power of their imagination. That will never change for so long as they are not challenged in clear and direct terms.
All of us who believe that Shiller’s research is legitimate should be challenging the Buy-and-Holders on everything that they believe about how stock investing works. Respectfully. Charitably. Non-dogmatically. Warmly.
But forcefully.
That’s how great learning experiences take place. It is though the conflict of ideas and the thinking that is inspired in the effort by those on both sides of a debate to sharpen their arguments that advances in understanding are achieved. We all are in the same boat. We all want to know as much about how stock investing works as possible. So all of us who believe that Shiller is right should be doing what we can to launch an exciting national debate as to whether or not the Buy-and-Holders got it all wrong.
We should remain open-minded. We should demonstrate our gratitude for all that the Buy-and-Holders have taught us over the years. But we should not hesitate to say that the Buy-and-Holders got one very important part of the story -- the valuations part of the story -- terribly, terribly wrong. The Buy-and-Holders are not our enemies, they are our friends. And the way in which we show our respect for our friends is to take their ideas seriously enough to challenge them when they do not appear to stand up to scrutiny.
Rob’s bio is here.
