High Stock Prices Are Sticky

High Stock Prices Are Sticky
geralt / Pixabay

Increases in stock prices make stocks less appealing. So, in theory, price increases should cause price drops. But it doesn’t work that way at all. Price increases are sticky. Investors become reliant on the wealth generated by the price increases and resist the loss of it.

Get The Full Henry Singleton Series in PDF

Get the entire 4-part series on Henry Singleton in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues

Q2 2021 hedge fund letters, conferences and more

A Fundamental Force

Prices sometimes come down too, of course. But the overall direction of stock prices is generally upward. That’s because the underlying companies become more valuable as productivity generates wealth. But the usual rule is for stock prices to go up by more than the increase that would be justified by economic productivity. The CAPE value trends upward. Stock become increasingly overvalued over time until there is a bear market that resets prices to fair-value levels or lower.

Fund Manager Profile: Kris Sidial Of Tail Risk Fund Ambrus Group

invest Southpoint CapitalA decade ago, no one talked about tail risk hedge funds, which were a minuscule niche of the market. However, today many large investors, including pension funds and other institutions, have mandates that require the inclusion of tail risk protection. In a recent interview with ValueWalk, Kris Sidial of tail risk fund Ambrus Group, a Read More

This resistance to stock price drops is a fundamental force in the market. Without it, the market could test various price points and settle on the one that makes the most sense given the economic realities. But investors always favor high prices. It takes more in the way of bad economic news to pull prices down than it takes in the way of good economic news to pull prices up.

We favor high prices because they create the illusion of wealth. Investors treat the numbers on their portfolio statement as real even when they represent nothing more than irrational exuberance. In the eyes of investors, higher prices send a signal that it is okay to spend more and that their retirement plans are closer to being on track. Lower prices would signal a need to cut back on spending and to save more. So investors do what they can to keep stock prices high.

What can we do? We can deceive ourselves. The wealth generated by CAPE values higher than the fair-value CAPE value is not lasting. Irrational exuberance is temporary wealth. But it is only investors selling stocks that cause the temporary wealth to disappear. Irrational exuberance can be maintained through the ongoing self-deception of stock investors. For so long as we continue to believe that the numbers on our portfolio statement are real, those numbers continue to appear each month. The trick is never stopping to think about where irrational exuberance comes from and where it will soon be going.

This core reality of the stock investing project -- that stock investors have a strong incentive to deceive themselves about the value of their holdings -- permeates all discussions of the subject of how the stock market works. Shiller’s research shows that irrational exuberance never remains in place indefinitely. But that reality is ignored in 90 percent of the analyses published. We make plans for our future rooted in a belief that the values assigned by the market are real even though we have a vague understanding that research has been published showing that this is not so.

The Stickiness Of High Stock Prices

We would be better off to know the true and lasting values. To plan effectively, we need to know the real numbers. But we have an emotional desire not to come to terms with the realities. The emotional desire almost always prevails. We then employ our reasoning powers to concoct justifications for the market numbers. Most of what is said about stock investing is rooted not in reasoning but in rationalization.

The stickiness of high stock prices can cause us to misperceive our economic standing. The stock market is today priced at two times its real value. What if it were repriced to fair-value levels? Life would be harder for all of us. We would be a less wealthy people. We would have less confidence in our future. There would be more social conflict. Things would be a mess.

But of course that is how things are in reality even though the repricing has not yet taken place. Many of the economic advances that we have celebrated over recent decades were imaginary advances that were backed by nothing more than irrational exuberance, advances that could disappear into the mist at any moment.

It’s not just that high prices are sticky, It is that they become more sticky over time, as the distance between the temporary prices and the underlying realities that the numbers are intended to reflect grow larger. As prices rise higher, our ability to think clearly about how stock investing works becomes diminished. By the time prices reach the levels where they reside today, it becomes next to impossible even to state clearly what it would mean if the stock market were to continue to behave in the future as it always has in the past and return prices to fair-value levels.

The best time to get stock prices right is before they have traveled too far to the high side. But getting stock prices right does not seem too urgent a matter of business when overvaluation is limited. It is only when the situation gets scary that there is much felt need for corrective measures. But at that time the resistance to corrective measures is intense. Stock prices are sticky and they get more sticky as they get higher and there comes a time when they are so high that even mentioning the stickiness of stock prices is perceived as the violation of a social taboo.

Rob’s bio is here

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.”
Previous article Industry Reaction To The Latest Rightmove House Price Index
Next article Post Claiming 4th Coronavirus Stimulus Check Arriving In July Is A Hoax

No posts to display