Shiller’s Breakthrough Was Not to Show Us How Stock Investing Works, It Was to Show Us How to Change How It Works

Shiller’s Breakthrough Was Not to Show Us How Stock Investing Works, It Was to Show Us How to Change How It Works

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?

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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.

Preventing chaos

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.

Updated on

Rob Bennett’s A Rich Life blog aims to put the “personal” back into “personal finance” - he focuses on the role played by emotion in saving and investing decisions. Rob developed the Passion Saving approach to money management; Passion Savers save not to finance their old-age retirements but to enjoy more freedom and opportunity in their 20s, 30s, 40s, and 50s - because they pursue saving goals over which they feel a more intense personal concern, they are more motivated to save effectively. He also developed the Valuation-Informed Indexing investing strategy, a strategy that combines the most powerful insights of Vanguard Founder John Bogle and Yale Professsor Robert Shiller in a simple approach offering higher returns at greatly diminished risk. Tom Gardner, co-founder of the Motley Fool web site, said of Rob’s work: “The elegant simplicty of his ideas warms the heart and startles the brain.”
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  1. My investment strategies have worked fine, Sammy. If you presume that we are going to see a 60 percent price drop sometime over the next year or two or three, I am ahead of the game because I locked in a return of 3.5 percent real from TIPS and IBonds back when that was available.

    The only reason why I need to reenter the work force is because of the insanely abusive posting of a small number of Buy-and-Holders (and because of the reluctance of the larger community of Buy-and-Holders to call them out on their abusive and in some cases criminal behavior.) The conclusion that people should draw from that is that there is something wrong with the Buy-and-Hold strategy. If advocates of the strategy believed that they could defend it in civil and reasoned discussion, they would avoid abusive tactics.

    You follow the strategy, I am sure of that. To that extent, you have confidence in it. But you believe that the strategy will lose supporters if people who do not believe in it are permitted to make the case against it in civil and reasoned discussions. So your level of confidence is not at all high. That’s the worst of all worlds You have enough confidence to go with the strategy but not enough to stick with it when your belief in it is tested, which is what will happen in the next price crash.

    Please consider for a moment what it means that stock prices always drop to a CAPE value of 8 at the end of a bull/bear cycle That’s crazy. Why would we as a people elect to price our holdings at one-half of their fair value, making ourselves feel like we are much poorer than we are in reality? That’s just as crazy as the irrational exuberance we are living through today. It’s irrational depression. Do you know what brings that on? We get to those crazy low prices when the last Buy-and-Holder gives up and sells.

    Shiller’s breakthrough is to show that stock investing is primarily an emotional endeavor, not entirely a rational endeavor. Your abusive posting is evidence that Shiller is right. To post abusively is to give in to emotional impulses. We should be talking about this stuff on every site. The Buy-and-Holders cannot imagine talking about abusive stuff because they cannot imagine talking about emotional stuff. But this is the stuff that drives stock prices, according to Shiller’s Nobel-prize-winning research.

    Emotional (But at Least I Am Aware of It and Try to Rein It In) Rob

  2. You have said that we should avoid retirement failures and (as said above) be focused on effective investing. Those are your words. Why do you avoid taking about your track record and your own experiences? Don’t you think people can learn from your failures?

  3. You seem to either want to avoid the topic or not give the whole truth, so let me fill in the blanks. In May of 2002, you stated that you had a nest egg of $400k, invested in i bonds, TIPS and CDs (you left that part out about CDs). Your budget was for 30k a year in spending. Unfortunately, spending went up faster than you expected, because your update in 2005 indicated spending of $38k. Clearly, your investments were geared for the short term because you said that the stock market returned 7% real, but that with VII you expected to gets returns in excess of that (yet you are now saying you are at 3.5% real, which is also unlikely and you would have eaten up a good part of your nest egg given these facts). You have also confirmed many times over that you did not get back into stocks.

    Shall I post your words from 2002 and 2005?

  4. We can all read your history, including your retirement plan. It isn’t pretty and revisionist history doesn’t help. No one, including buy and holders told you to quit your job. In fact, many told you it was a bad idea. If people followed your advice as to staying out of the market, they would likely have a failed retirement, just like you.

    Stating facts and speaking honestly is not abusive. Your lying is what is abusive.

  5. There’s only one issue in the stock investing realm that I have ever written about, Sammy. I don’t believe that I have anything special to offer re any other issue and so I just keep my mouth shut on all of the other issues. But I believe that the one issue that I write about is huge. The one issue that I write about is the far-reaching implications of Robert Shiller’s Nobel-Prize-winning research showing that valuations affect long-term returns.

    If that’s so, it changes everything that we once believed about how stock investing works. We all want the same things. We all want to become effective investors. So you would think that there wouldn’t be one dissenting voice to my proposal that we permit open and frank discussion of the how-to implications of Shiller’s “revolutionary” (Shiller’s word) research findings at every discussion board and blog on the internet. I am here to tell you that there is a whole big bunch more than one dissenting voice to that one. About 10 percent of the population loves my stuff. But another 10 percent hates it so much that they cannot stand it. The 80 percent in the middle is okay with the idea of permitting me to talk. But they don’t feel strongly enough about it to object too much when the 10 percent of super intense Buy-and-Holders demands that I be banned. So I almost always end up being banned sooner or later.

    Why the super intense reactions? Paradoxically, it is because Shiller’s research is so darn wonderful. If Shiller is right, it was the relentless promotion of Buy-and-Hold strategies that caused the 2008 economic crisis. If Shiller is right, most of the gains that we experienced in the late 1990s were not real and lasting but just the product of irrational exuberance. When those trillions of dollars disappeared, we were going to see consumer spending power diminish by trillions of dollars. Obviously, that caused an economic crisis because the loss in consumer spending power puts hundreds of thousands of companies out of business and left millions of workers jobless. Bad stuff. That’s the power of a bull market to hurt us all. That’s the power of Buy-and-Hold (which caused the bull market by assuring investors that there is no need to practice market timing when buying stocks) to hurt us all.

    We should all be jumping up and down in excitement that Shiller provided us the missing piece in the stock investing puzzle. But the reality is that it is hard to make a transition like this. The vast majority of people who are viewed as experts in this field became experts pushing Buy-and-Hold. They don’t want people to explore the research showing that they got it wrong. And the vast majority of investors bought into the Buy-and-Hold idea and have felt great gratification seeing the strategy appear to work. They don’t like the idea of admitting a mistake either. So we are caught in an in-between place. Those who pay attention to the peer-reviewed research know what works. But very few are willing to “cross” the Buy-and-Holders by speaking openly and frankly about what the last four decades of peer-reviewed research teaches us all.

    I think this is the biggest public policy issue facing the United States today. I could write about it for another 10 years and never run out of material. It is fascinating to explore all the ways in which Shiller revolutionized the field. I believe that lots of people will be getting in on this in the days following the next price crash, when lots of people who bought into the Buy-and-Hold concept will be more open to hearing challenges to it. We’ll see.

    My best wishes to you and yours.

    One-Issue Rob

  6. Look at what you wrote. You say we all want to become effective investors. But you haven’t, nor has anyone successfully implemented VII. The rest of your post is basically repetitive talking points, most of which, are not true. Thus, my point about things that could provide real value to readers.

  7. You have written this same stuff thousands of times. Why don’t you try writing something new that people can learn from and actually see value. Use your own life experiences. Tell people about how your retirement plan failed and what you learned from it. Tell them about how you have to go back to work and how you are looking for a job. Give tips to those that are over 60 and are like you in having to return to the job market. Tell them about how market timing failed for you. Tell them how they should not listen to predictions of the stock market as they are mostly wrong. Try being real instead of living in an imaginary world. We have enough people faking out there.

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