You look at your portfolio statement. It tells you that the value of the stocks you own is $100,000. And then a friend of yours mentions that this Shiller fellow doesn’t but it. Shiller says that, when stocks are priced at two times fair value, half of that $100,000 number reflects nothing more than irrational exuberance. The real, lasting value of your portfolio is $50,000. And Shiller has been awarded a Nobel prize in Economics.
Nobel prize or no Nobel prize, most of us tune it out. This doesn’t have to be complicated. The purpose of the portfolio statement is to tell you the value of your holdings. And the statement says that the correct number is $100,000. If you elect to cash out, you will receive a check for $100,000. So that’s it. What’s this irrational exuberance stuff? You have a stock portfolio with a value of $100,000. That’s the deal.
The ExodusPoint Partners International Fund returned 0.36% for May, bringing its year-to-date return to 3.31% in a year that's been particularly challenging for most hedge funds, pushing many into the red. Macroeconomic factors continued to weigh on the market, resulting in significant intra-month volatility for May, although risk assets generally ended the month flat. Macro Read More
I of course do not believe that that’s the deal. I think that Shiller is on to something important. The portfolio statement says what it says because as a society we have made a collective decision to count irrational exuberance as real. We don’t even permit the implications of Shiller’s ideas to be discussed in an in-depth way at most internet sites. We want to believe that the numbers on our portfolio statements reflect reality. So we tune out challenges to those numbers and thereby keep our confidence up.
But the purpose of research is not to tell us what we want to hear. Marketing people can do that. The purpose of research is to dig deep and discover things about how stock investing works that are not intuitive, that are not widely known, that perhaps are even more than a little difficult to accept. That’s Shiller. That’s what he did with the 38 years of “revolutionary” (his word) peer-reviewed research that caused him to be awarded that Nobel prize. Shiller questioned our most fundamental beliefs about how stock investing works. And he backed up what he said with data. That’s an amazing trick.
If 50 percent of our stock holdings are backed not by economic realities but only by irrational exuberance, the world is a very different place than most of us today imagine it to be. We are not as wealthy as we think we are. Our pension plans are in trouble because the people running those plans are counting on the normal stock return applying in years to come but that number will not apply until after prices have crashed hard. Lots of businesses that appear to be doing well are in big trouble because a price crash will take trillions of dollars of spending power out of the economy. Millions of workers will lose their jobs when those businesses fail. The economy will go into a recession. The onset of a recession will influence the political campaigns.
All of the possibilities that I am raising are negative ones. That’s why we don’t like to discuss the implications of Shiller’s findings. The world would be a better place if we really did possess the amount of wealth that our portfolio statements assure us that we possess.
The other side of the story is that, if we really only possess one-half of that amount of wealth, we are better off knowing that now than waiting for the price crash to hit us with the reality. Knowing now permits us to plan for the future far more effectively. If Shiller is right, he has made the world a better place by publishing his research. The full truth is that we wouldn’t even be in this jam if we had begun taking Shiller’s research findings seriously as soon as they were published. Stock prices cannot reach dangerously high levels in a world in which investors understand that there are some price levels at which stocks no longer offer a strong long-term value proposition because in such a world investors would engage in the price discipline needed to keep stock prices from getting out of hand.
So Shiller did what researchers are supposed to do. He challenged our thinking on an important subject. He didn’t report something obvious. He wasn’t one more fellow saying “hey, you know those numbers on your portfolio statement -- they are accurate, you can trust them.” He upset the applecart. He told us something new and important. He told us that those numbers are not accurate, at least not in the long term. He told us that the numbers on our portfolio statement are not lasting numbers, they are numbers that reveal how as a society we think about stocks at this point in time but not how we will think about them when we come to our senses and send prices back down to more reasonable levels.
I became a Buy-and-Holder once upon a time because Buy-and-Hold was promoted as a research-based strategy and I wanted my retirement money to be invested pursuant to ideas that had been tested and that had survived the tests. I lost confidence in Buy-and-Hold when I learned through my interactions with thousands of investors on the internet that the majority of Buy-and-Holders don’t care to come to terms with Shiller’s findings, that the majority of Buy-and-Holders find appeal only in the research published prior to 1981.
Shiller helped us all by publishing important research. He made us richer. People don’t see it that way. People feel that Shiller is trying to deplete their wealth when he shows that they need to divide the number on their portfolio statement by two to know the true value of their stock holdings. But Shiller made us richer. We are better off knowing the realities. The realities are hard to accept at a time when stocks are so wildly overpriced. But when prices drop we will see that we all would have been better off had we recognized all along that Shiller was telling us something important.
It is the research that surprises you the most that helps you the most. Shiller’s work is confounding and unsettling. Shiller’s work is of huge importance.
Rob’s bio is here.