Robert Shiller’s Nobel-prize-winning research findings are amazing. He showed that valuations affect long-term returns. That means that stock investing risk is not constant but variable. It follows that market timing is mandatory for any investor who wants to keep his risk profile constant over time.
It also follows that stock returns are to a large extent predictable over the long term. Shiller revolutionized our understanding of how stock investing works. Just about everything that we had come to believe in the pre-Shiller era re how stock investing works needs to be reexamined in light of his research findings.
Looked at from another perspective, however, it’s all pretty darn unremarkable.
Valuations Affect Long-Term Returns
To say that valuations affect long-term returns is to state the obvious. There are thousands of markets in existence. There is a market for pencil sharpeners and there is a market for paper clips and there is a market for cotton balls and there is a market for bowling balls. In every last one of them, the price that is paid for the product being offered for sale affects the value proposition obtained by making the purchase.
What Shiller showed is that it works that way with stocks too. Common sense could have told us that. It’s certainly a nice thing that he reaffirmed the merit of looking at things with a common-sense perspective. But I think it would be fair to say that it’s more than a little odd that someone would be awarded a Nobel prize for doing that.
Shiller’s research findings are both amazing and unremarkable. A hard one to pull off.
What made it all possible is that our understanding of how stock investing works was completely upside down when Shiller came on the scene. The old understanding was that the stock market was efficient, that investors acted in the rational pursuit of their self-interest when buying stocks.
If that were so, Buy-and-Hold would be the ideal strategy and market timing would not be required. And today’s CAPE value would not be 29 or anything even remotely close to it. That would be a different world altogether.
It would be a world that makes sense. That’s why the smart people who developed the Buy-and-Hold strategy were drawn to it. Stock investing should make sense, should it not? People have their retirement money invested in stocks. You would sure think that they would want to make level-headed decisions about it.
Except for one thing.
Shiller’s Research Findings Show Markets Have Never Been Efficient
Most stock investors are humans. Just about all of them, really. When the humans fall in love, they often fall in love with the wrong people. The humans gamble to excess at times. They drink to excess too. They smoke. They argue over nonsense.
The humans don’t make sense! They are capable of rationality. Even the worst of the smokers are capable of holding down a job doing productive work. So the humans are capable of fooling you into thinking that they are rational creatures. But it is not so. Read a novel or listen to a song or watch a movie and you will be tipped off to the realities that the ivory tower economists responsible for the Buy-and-Hold strategy missed out on. The humans are an emotional bunch. The last thing that the market is is efficient.
Shiller could have just said that. Just saying it clearly would have been a solid contribution. But he did more. He showed with data that it has always been so. The market has never been efficient and Buy-and-Hold has never worked and market timing has always been required to get prices back to where they should be after the emotional humans sent them to crazy places where they cannot possibly reside for long.
Shiller offered an amazing insight. He merited his Nobel prize. But he did it by advancing the most commonplace of observations: investing is done by humans! Who ever would have thunk it? Stock investing is just like every other activity performed by the emotional humans.
There are elements of rationality that go into it. But to a large extent it is controlled by crazy zigs and zags that are inexplicable to the kind of individual who is overly impressed by ivory tower economic pronouncements.
It is because Shiller’s insights are so obvious that they are so sweeping. They affect everything. If stock investing really is done by humans (it is), everything that was said about it in the days when most of the experts were presuming complete rationality is off the mark. So we need to rewrite all the textbooks.
That’s why Shiller’s insights are perceived to be so threatening by the people whose names are on those textbooks and by the people who for a long time have been making a good living telling thousands and thousands of others about what those textbooks recommend re the investment of one’s retirement money.
Knowing the obvious truths will change everything, We all will get to live better and fuller and richer lives someday in the not too distant future. But not just yet.
Mark Twain once observed that it’s not the things you don’t know that hurt you the most, it’s the things that you know for certain that just ain’t so.
Rob’s bio is here.
