How Should We Measure The Success Of Shiller’s Ideas?

Updated on

Robert Shiller is a failure.

I don’t really believe that. I rate Shiller’s Irrational Exuberance as the most important book about stock investing ever published. I believe that Shiller merited his Nobel prize. I believe that his research revolutionized our understanding of how stock investing works. I believe that Buy-and-Hold is the past and that Valuation-Informed Indexing is the future.

Get The Full Series in PDF

Get the entire 10-part series on Charlie Munger in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.

Q2 hedge fund letters, conference, scoops etc

But still….

There’s a question that I ask my Buy-and-Hold friends. I point out that, if Shiller’s research is important enough for him to have been awarded a Nobel prize, he must have changed our thinking on how stock investing works in numerous ways. I ask them to list 10 concrete ways in which their investment strategies have changed as a result of Shiller’s findings. When they don’t respond, I ask if they can list five ways. Then I ask if they can list just three ways. Or perhaps one.

Shiller hasn’t changed anything. He is a failure. We are investing in stocks in the same way that we invested in stocks before he came on the scene.

There’s an easy way to check this. Shiller employs the CAPE metric to determine when stocks are dangerously overpriced. If he has persuaded people of his case that valuations matter and that stocks do not offer as strong a long-term value proposition when they are priced high, we should be seeing more investors paying attention to price and lowering their stock allocations when prices get high. That would bring the CAPE value down. We should be seeing the lowest CAPE values in history now that Shiller’s work has been widely praised and made widely available.

We are not seeing that. Shiller published his first bit of “revolutionary” (the word appears in the subtitle to Shiller’s book) research in 1981. The CAPE value hit its highest level in the history of the U.S. market in 2000. The highest we had seen before then was the “33” that brought on the Great Depression. In 2000, we hit “44.” And we are still near 30 today. If Shiller has been teaching us how important it is to exercise price discipline when buying stocks, we are very bad students.

In a way, though, what we are seeing is consistent with Shiller’s theory.

Shiller says that investing is not a 100 percent rational endeavor, as the Buy-and-Holders claim, but a highly emotional endeavor. If that were true, high prices would not make us reluctant to buy stocks because of the poor long-term value proposition but super excited to buy them because of how the big numbers on our portfolio statement appeal to our Get Rich Quick impulse. In a rational world, high CAPE values are a warning sign. In a world in which investors are highly emotional, the world that Shiller believes we live in, high CAPE values are proof that stocks are the best asset class out there.

Shiller’s work explains what is going on in the market today. But it has not yet influenced the behavior of investors.

I believe (I hope!) that Shiller’s work will begin to influence our behavior when the shock of falling prices breaks through the emotional wall of resistance we have to the idea that price matters as much when buying stocks as it does when buying anything else. Shiller has not had great influence yet because we are fighting his message. We fight his message because he is right that it is emotion and not reason that dominates the stock-buying decision-making process.

I believe, though, that it may be that Shiller has had more influence than what a look at today’s CAPE value suggests. The funny thing about emotions is that they can work silently for a long time before producing visible consequences. We all experience conversion experiences from time to time. We change political parties. Or we break off a relationship that had been important for a long time. Or we quit a job. There’s a sense in which those changes take place suddenly. Someone not paying close attention might think that we were happy with our job right up to the day that we handed in the resignation. The reality is that it almost never works like that. Sudden change occurs only after a long and slow process of gradual erosion of old beliefs. Emotional allegiances bend and bend and bend unseen and then very visibly snap.

Most investors have heard of Shiller and know that he thinks that valuations are more important than we once realized. Most investors know that Shiller’s work is respected and ponder from time to time whether they should pay more attention to his arguments. But there is a great resistance in the Buy-and-Hold mind to Shiller’s message. If valuations matter, they matter a great deal. It is hard to come up with a way in which believing in Shiller could result in only a small change in one’s investment strategies. Most investors don’t want to consider big chances in their investment strategies for so long as prices remain high. So the idea of taking Shiller’s ideas seriously gets put on the shelf for reconsideration at a date sometime in the unspecified future.

Those ideas are percolating in the background in millions of investor minds today. I believe that they will come to a quick boil soon after the next price crash hits. Then we will see the emotional allegiance to Buy-and-Hold that has been bending and bending and bending unseen for so long now finally and irreversibly snap.

Rob’s bio is here.

Leave a Comment