Robert Shiller recently wrote an article arguing that today’s CAPE level isn’t as “absurd” as it seems because interest rates are so low. I don’t buy the argument. Today’s CAPE level is in the same general neighborhood as what we saw just prior to the onset of the Great Depression. So I find it very scary and I don’t think that people should be making excuses for it.
Low Interest Rates Make Stocks Appealing
I can’t help but wonder what prompted Shiller to write the article. He is the world’s leading proponent of the idea that valuations matter. So he’s not someone who would be expected to make excuses for a super high CAPE level. Shiller didn’t just learn that low interest rates make stocks relatively more appealing. That argument has been popular among the valuations-don’t-matter crowd for as far back as I can remember. So why is he finding enough merit in the idea today to write an article about it?
Baupost’s Seth Klarman: the Fed has broken the stock market [Q4 Letter]
Baupost founder Seth Klarman told investors that the large amounts of stimulus that have been poured into the world's economies are masking the severity of the problems caused by COVID-19. Q4 2020 hedge fund letters, conferences and more In a letter seen by the
My guess is that the long period of time in which stock valuations have remained at super high levels is putting Shiller on the defensive. Shiller published a paper in July 1996 predicting that investors who stuck with their high stock allocations despite the high valuations of the time would live to regret it within 10 years. That prediction made perfect sense given how stock had always performed up until that time. But of course we are now 14 years down the line from 2006, the year by which Shiller was predicting we would see a price crash. Shiller’s not the only one who has been surprised by the length of this bull (I too have made predictions of price crashes that failed to materialize). But my guess is that the exceptional length of this bull market may be getting to him.
Keeping Valuations In Mind
Stocks just aren’t performing as they always have in the past. That’s the reality. Shiller’s 1996 prediction assumed that the historical return data was telling us something valuable about how stock would perform on a going-forward basis. That hasn’t happened. So I suspect that Shiller may be backing away a bit from his long-held position that valuations always need to be kept in mind when making strategic assessments.
Wade Pfau took a stronger position of the same general type in a recent comment. Wade worked with me a number of years back on research that showed that long-term market timing has always worked. He said at the time that: “Market timing provides significantly higher returns at a comparable level of risk.” However, in his recent comment he expressed a belief that something basic in how stock investing works changed in 1996 and indicated that he is no longer a believer in market timing.
Again, I suspect that the long bull market is getting to him. If Shiller’s Nobel-prize-winning research is legitimate, half of the value of the market today is the product of irrational exuberance rather than of economic realities and should be disappearing into thin air in not too long a time. That’s been so for a long time. And it hasn’t happened. It gets hard to maintain a belief in the importance of market timing in conditions like these.
Did Stock Investing Change In 1996?
Is it so? Did the basics of stock investing change in 1996?
I don’t think so.
If things changed, it wouldn’t have been in 1996, it would have been in 2006. Remember, Shiller found nothing remarkable in the idea of prices remaining high until then. It is only the last 14 years of the bull market that is unprecedented.
We are in uncharted waters. That much is certainly so. But I find the idea that how the market works has changed in a dramatic way hard to swallow. What would cause such a change? Wade did not address that question. If the market has not changed, then the research showing that market timing works is valid. And that research was based on data going back to 1870. So there is 136 years of data supporting market timing and only 14 suggesting that it may not work. I have a hard time accepting the idea that market timing does not work when the time-period in which it did work is so much longer than the time-period in which it has come under question.
Something Changed In 2006
It would be a big thing to conclude that something changed in 2006. If that were so, wouldn’t that throw into question all of the research that looked at data from years prior to 2006? We don’t know what this mystical something is that supposedly changed. How can we know what adjustments are needed in all of the research from earlier years to take into account this mystical something?
This is the longest bull market that we have ever seen. People need to know that. It certainly shows that we cannot make precise predictions as to when price crashes will take place. Short-term timing doesn’t work. But long-term timing does. The long delay in the price crash does not justify calling that one into question.
Rob’s bio is here.