Irrational Exuberance Didn’t Start With Buy-and-Hold

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The Buy-and-Holders made a terrible mistake. Robert Shiller’s Nobel-prize-winning research showing that valuations affect long-term returns was not available at the time the strategy was being developed and they advanced the dangerous idea that market timing/price discipline might not always be required.

Now we are stuck in a crazy twilight zone where we know from the research that it is but in which most of us are afraid to point out that the Buy-and-Hold emperor is wearing no clothes because it makes them feel bad for people to learn about the mistake.

I think we all need to make an effort to speak more forthrightly about these matters. But….

I don’t think it’s fair to pin all the blame on the Buy-and-Holders.

The Efforts Of Our Buy-and-Hold Friends

The Buy-and-Holders were doing something wonderful. They were making investment analysis an academic discipline for the first time ever. I view that as a major advance. I wish that we had taken Shiller’s amazing research findings and run with them 42 years ago. It’s painful to consider how many powerful insights into how stock investing works we have missed out on by not doing so.

But the full reality is that it was the transformation of investment analysis into an academic discipline that set the stage for the publication of Shiller’s research in the first place. We might not know today how important it is that all investors engage in market timing if it hadn’t been for the efforts of our Buy-and-Hold friends!

The Buy-and-Holders say all the time that market timing is not required. But they really were not the ones who came up with the idea. The CAPE value hit “33” in the days before the onset of the Great Depression. We can’t blame the Buy-and-Holders for that one! They weren’t around at the time. The cause of that crazy CAPE value was the Get Rich Quick urge that resides within all of us.

We all want something for nothing and stocks are an asset class that permits us to get it. If we all just act in concert to send stock prices soaring and follow an implicit agreement not to think about the dangers that must follow from doing so, we can all for a time fool ourselves into thinking that we possess more wealth than we really do possess. There’s strong temporary appeal in that idea!

Seeing Through The Illusion

I wish that the Buy-and-Holders would have seen through the illusion. If they couldn’t see through it in the 1960s, when they were developing their strategy, they could have at least acknowledged their error when Shiller published his amazing research in 1981.

The Buy-and-Holders have always urged investors to make use of the peer-reviewed research in deciding on their investment choices. Why did Shiller’s research become the exception to the rule, the one research paper that must never be mentioned in polite company? That was a truly unfortunate development.

But I think it must be noted in fairness to the Buy-and-Holders that they did not advance an entirely new idea when they urged inventors to refrain from market timing. Stock investors had been doing that all along. We could never have gotten to that CAPE value of 33 if we had all been faithfully lowering our stock allocations in response to rising price levels. It was human nature that caused those crazy prices.

And it is still human nature playing that terrible trick on us today. The popularity of the Buy-and-Hold strategy made it worse. When we are trying to convince ourselves that it might all turn out different this time, that this might be the first time in history when market timing/price discipline turns out not to be absolutely necessary, the Buy-and-Holders are always around to assure us that market timing is not required at all. So we have achieved higher CAPE values in recent years than the one that brought on the Great Depression. Buy-and-Hold has made things worse.

But Buy-and-Hold did not create the problem. It was there before the first research paper in this field was published. The Get Rich Quick urge that tells us that there is no need to practice price discipline when buying stocks resides within us. We don’t need to read anything or to hear anything from advisers to come to believe that stocks are the one thing we can buy without taking price into consideration. We desperately want to believe that and we always have. It’s a natural!

Can we get over our natural self-destructive inclinations? I believe that we can. And I believe that, when we do, we will have the Buy-and-Holders to thank for placing us on a path that led in time to the discovery of the critical importance of market timing. It’s Shiller’s research that is going to do that and it was the importance that the Buy-and-Holders placed on research that will have steered our minds to concluding that we should take a closer look at Shiller’s research.

It is unfortunate in the extreme that it has taken so long for us to get there. But we are inching our way to a good place all the same. And the Buy-and-Hold mindset (which really does oppose market timing but which also really does support looking at the peer-reviewed research) has been playing a positive role in the story all along.

Rob’s bio is here.