I often refer to Buy-and-Hold as a “Get Rich Quick” investment strategy. Buy-and-Holders don’t like that one little bit. They believe that their strategy is research-based. They see that as its primary appeal.
Valuations Affect Long-Term Returns
But Shiller’s research showing that valuations affect long-term returns changed all that. In pre-Shiller days, the widespread thought was that the market is efficient. If that were so, market timing would not work and Buy-and-Hold would be the ideal strategy. But if valuations affect long-term returns, stock investing risk is not constant but variable and market timing is required for those who want to keep their risk profile constant over time.
Last year was a banner year for hedge funds in general, as the industry attracted $31 billion worth of net inflows, according to data from HFM. That total included a challenging fourth quarter, in which investors pulled more than $23 billion from hedge funds. HFM reported $12 billion in inflows for the first quarter following Read More
In that world (the world we live in, according to Shiller’s research), stock gains that are backed only by irrational exuberance and not by economic realities are not lasting. Investors can elect to generate such gains for themselves. But they are only fooling themselves when they do. Irrational exuberance never lasts. I think it would be fair to say that investors who elect to pump up their returns in this way are practicing a Get Rich Quick approach to investing. They are not creating wealth, they are creating the illusion of wealth.
Buy-and-Holders are in the majority today. About 90 percent of today’s investors believe either that market timing does not work or is not required. As a general rule, that group does not like hearing from the 10 percent that believes that Shiller’s Nobel-prize-winning research is legitimate research. It is unsettling for them to hear that a large portion of their retirement income may disappear into thin air at any moment.
Investors Ignore Shiller's Ideas
So investors do not hear both sides of the investing story equally. Buy-and-Hold is heavily promoted today, Valuation-Informed Indexing is hardly promoted at all. But the discussion of Shiller’s research findings has not been entirely suppressed. Shiller’s book is available in libraries everywhere. His Nobel prize was widely reported on and commented on. He appears not infrequently in both print and video interviews. Shiller’s ideas have been ignored by most investors. I don’t think that it would be fair to say that his ideas have been rejected by most investors because most investors have not given his ideas serious consideration. But they have certainly not been widely accepted. Yet they have left a mark all the same.
How will we know when Shiller’s ideas have caught on? It will be easy to tell. The CAPE value will drop dramatically when more people begin paying attention to Shiller’s ideas. Another way of saying it would be, when more people begin paying attention to Shiller’s ideas, the CAPE value will drop. It is not possible to have a CAPE value of 35 in a world in which Shiller’s research has been embraced by the majority of investors. Investors can act against their self-interest but they cannot do so with deliberate intent.
So what we are seeing when we watch stock prices rise and fall is a battle between the two parts of each investor’s mind. There is a part of all of us that craves something for nothing. That is the Get Rich Quick/Buy-and-Hold part of our brain. It is the part that reacts defensively when talk of Shiller’s research findings is advanced. And there is the rational/research-driven part of our brain. That part wants to know the realities. That is the part that eventually gets frightened about investing in an asset class with a CAPE value of 35 and sends that CAPE value sharply downward as a result of those fears.
Get Rich Quick vs Research-Based Investment Strategies
The market is holding a referendum on Shiller’s model for understanding how stock investing works. Every day. As of today, Shiller has been rejected. But that will not always be so, not if stocks continue to perform in the future at least somewhat as they have always performed in the past. There is a natural tension between the Get Rich Quick and the research-seeking parts of our brains. It is the resolution of that tension that determines each day’s stock price.
Right now, Shiller’s research has been all but banished from the thinking of stock investors. But the tension is never resolved in a final way. The part of the investor brain that finds satisfaction in knowing what the research says becomes alarmed to discover the research-based thoughts are being given as little credence as they are being given today. That alarm causes the reason-based stuff to become more influential for a time.
Investors are not 100 percent rational, as the Buy-and-Holders once supposed. They are not purely emotional creatures either, as they might sometimes appear to be. If investors were 100 percent rational, the CAPE value would always reside somewhere not too terribly far from its mean value of 16 (perhaps moving up and down within a range going from 12 to 20). If investors were 100 percent emotional, prices would only go upward and never downward. In the real world, there is a never-relenting tension between the rational and the emotional being worked out on a daily basis.
Rob’s bio is here.