What did Robert Shiller do? Practice market timing?
He was awarded a Nobel prize in Economics. He must have made an important contribution to our understanding of how stock investing works. What was it? How did stock investing change as a consequence of Shiller’s research?
In a rare interview with Harvard Business School that was published online earlier this month, (it has since been taken down) value investor Seth Klarman spoke at length about his investment process, philosophy and the changes value investors have had to overcome during the past decade. Klarman’s hedge fund, the Boston-based Baupost has one of Read More
Some would say that he challenged the validity of the Efficient Market Theory (and thus of the Buy-and-Hold Model for understanding how stock investing works). He certainly did that.
Some would say that he showed that valuations affect long-term returns, which is another way of saying that he showed that stock investing risk is not static but variable. That was obviously an important breakthrough.
Did Shiller show us how to practice market timing?
Some would say that he showed us how to time the market effectively. Since risk increases when valuations go higher, investors who want to keep their risk profile roughly constant over time now know that they must adjust their stock allocation in response to big valuation shifts and that they can earn higher returns while taking on less risk by doing so. That’s another big one.
However, Shiller’s biggest contribution was not to show us how stock investing works, it was to show us how to change how stock investing works. Shiller started a conversation that down the road will permit us to gain a level of control over our stock investments that we never possessed before.
I often quote the words from Shiller’s book in which he predicted the 2008 economic crisis. He said that: “"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." The crisis was obviously a scary experience. Hundreds of thousands of businesses went belly up.
Millions of workers lost their jobs. We saw political frictions increase. And the saddest thing is that the CAPE level today is back where it was in the days leading up to the 2008 crisis. All signs are that we are headed for a resumption of the 2008 crisis in the not-too-distant future.
It’s good that Shiller’s work helps us to understand what caused the crisis. We need to come to terms with it. And understanding that there has been an economic crisis on every occasion on which large numbers of stock investors became price indifferent certainly helps in that regard.
But Shiller did much more than describe why high stock prices inevitably lead to economic crises. He showed us what we must do to avoid economic crises. He empowered stock investors.
What do we need to do? We need to practice market timing. That’s the answer. Investors practice market timing because they appreciate that stocks offer a stronger value proposition at some times than at others. It is through market timing that investors practice price discipline when buying stocks. And of course price discipline is what makes the market function effectively. Markets in which market timing is not practiced (that is, markets in which Buy-and-Hold thinking has become dominant) always collapse sooner or later. How could they not?
Where we are today
Shiller showed us how to avoid getting into the sort of jam that we are in today. The problem that we face today is that prices are so high that investors react negatively to hearing what the peer-reviewed research tells us about how to identify the true and lasting value of their stock portfolio. Investors would be much more receptive to Shiller’s message if prices were lower. If only Shiller’s model had become dominant before prices got out of hand, they never would have gotten out of hand.
Once prices fall, much of the resistance to Shiller’s research findings will dissipate. From that point forward, we will be free to consider whether market timing is a good idea or not and to what extent we want to practice it. That will be a great liberating moment. From that point forward, it would be hard to imagine how prices could ever again rise to the dangerous levels where they reside today. Investors of course have a desire to act in their best interest.
Once it becomes socially acceptable for experts to point out the dangers of Buy-and-Hold strategies, more and more investors will discover the merit of market timing strategies and prices will never again reach the sorts of levels that bring on a collapse.
Shiller did indeed describe how stock investing works. But his primary accomplishment reaches far beyond the descriptive. He showed us how to make stock investing a less risky and more profitable investing choice. His research does not just describe what is going on in the market. It gives us all the tools we need to change what is going on in a very big and very positive way.
Three cheers for market timing!
Rob’s bio is here.