Robert Shiller recently wrote an article for the New York Times discussing expert opinion and stock returns. Shiller argues that “Gut Feelings Are Driving the Market” (that’s the headline) and that “Valuations are high, but investors are still willing to hold because of a visceral emotion driven by President Trump” (that’s the sub-heading).
He notes that: “People will point this year to low interest rates to justify the high C.A.P.E. ratio. But interest rate levels historically have not correlated well at all with the C.A.P.E. For example, low long-term rates did not explain the high C.A.P.E. ratios in 1929 and 1999, nor did rising long-term interest rates explain subsequent market crashes.”
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Shiller instead casts the blame for today’s high stock prices on “animal spirits,” which he defines as “a sense of optimism and ready energy to be entrepreneurial and take risks.” He observes that: “Animal spirits are not adequately measured by business consumer confidence indexes, because the surveyors do not probe for such deep feelings;” and that “high animal spirits in the stock market are often associated with the disparagement of traditional authority and expert opinion.”
In Shiller’s assessment, “The question for the market outlook hinges partly on how the Trump narrative — the notion that he and his followers are on the road to a triumphant future — will evolve.”
Shiller attributes today’s high stock prices to “the rise of an explicit belief in irrationality, saying that “there is reason to think that respect for science has been diminishing over the past decades.” He acknowledges that “this ‘gut feeling’ narrative is not conterminous with the current bull market in its entirety” but asserts that it “seems to be an important factor permitting the United States economy and markets to move ahead amid widely reported fears of a coming global recession.”
I find this analysis unconvincing (while my general view is of course that Shiller’s work is the most important work being done in this field).
Market valuations and expert opinions
Prices have remained super high during the first three years of Trump’s presidency. But those three years represent only a tiny portion of this very, very long-running bull market. Shiller published a paper in July 1996 warning investors who stuck with their high stock allocations despite the dangerous stock prices that applied at the time (the CAPE value was in the mid-20s then) would live to regret it within 10 years. Shiller’s comments made perfect sense given the history of U.S. stock prices up until that day.
But of course most Buy-and-Holders do not today regret sticking with their high stock allocations over the past 24 years. Stock prices have remained super high since Shiller ventured forward with that prediction, with the only exception being a few months following the 2008 crash, where prices went a small bit below fair-value levels before rocketing to super high levels again a few months later.
Little of that was due to any emotions that Trump had inspired in stock investors. I understand that Shiller is making a broader point. He is saying that it is not Trump himself that is causing high stock prices but a diminished respect for rigorous scientific analysis and a heightened willingness to go with one’s gut that in his view the Trump phenomenon epitomizes. It is true of course that many Trump supporters denigrate widely recognized experts. So I can am not entirely lacking in sympathy for Shiller’s take on why prices have risen and remained so high for so long.
Expert opinion and stock prices
But I come at this from a very different direction. In my assessment, an improper reliance on science is a big part of the problem. Eugene Fama was awarded a Nobel prize, just as Shiller was. Advocates of Buy-and-Hold argue that it is rooted in science. I was once a Buy-and-Holder myself and the reason why I was drawn to the strategy was its claim to be rooted in science. Today’s high prices are the result of a misplaced acceptance of bad science, not the result of a rejection of science in favor of gut feelings.
The Trump phenomenon evidences a diminished respect for established authorities, that much is certainly so. My take is that many of us, both Trump supporters and Trump critics, have come to lose a measure of respect for expert opinion in recent decades, not because we prefer going with gut feel but because in some cases expert opinion has failed us in big ways. The Vietnam war was the first big case in which experts assured us repeatedly of things that the realities on the ground did not show to be so. Another big case of this was the Enron scandal, where the smartest guys in the room just did not seem to have it together. And of course the 2008 economic crisis added to a growing feeling that we can no longer trust experts to tell us the straight story.
Trump and stocks
Trump is a populist. It is fair to say that the Trump phenomenon signals a loss of confidence in experts. But it is not my sense that people are losing confidence in experts because they prefer going with their gut, My sense is that there is a deep and growing feeling that experts have failed us in numerous cases. The investing advice realm is one area in which confidence in expert opinion remains high. It is my belief that that is unfortunate.
I believe that Buy-and-Hold is a gravely flawed strategy that remains popular because most of us still possess a good measure of respect for expert opinion despite its recent failures. My worry is that the next price crash will cause confidence in Buy-and-Hold to collapse and our general respect for expert opinion to diminish even further.
I share Shiller’s antipathy for the idea of going by one’s gut in making investment decisions. But I do not believe that stock prices are so high today because too many of us have elected to follow our gut feelings rather than place our trust in science. The Buy-and-Holders that I know possess a deep and sincere belief in the power of science to make sense of the world around them. The problem is that the experts who promote the strategy have not given sufficient consideration to the breakthrough research done by Shiller and a good number of others challenging beliefs that over time have hardened into dogmas. It’s a blind faith in discredited dogmas that is holding us back in this field, not a desire to go with our gut when making investment decisions.
Rob’s bio is here.