Shiller showed that irrational exuberance is a thing. Stock investors are not 100 percent rational, as the Buy-and-Holders posited. They get carried away. They push prices up to crazy levels and then we all pay the penalty when those prices inevitably come crashing back down to earth.
It’s a big advance in our understanding of how stock investing works. It changes everything. If irrational exuberance is a thing, we need to adjust the number on our portfolio statement for the effect of the pretend money if we want to know the true amount of our accumulated life savings. If irrational exuberance is a thing, we need to engage in market timing if we want to keep our risk profile constant over time.
It’s understandable that investors would resist this advance. Buy-and-Hold flatters us. It tells us that we are perfectly rational and that the inflated number on our portfolio statement is real. For so long as bull-market prices remain in place, Buy-and-Hold makes us look like geniuses. Shiller’s research findings undercut that exalted feeling. Acceptance of the irrational exuberance phenomenon would make us feel that we are not as smart or rich as we have been led to believe we are. So we block out recognition of the critically important reality.
But there’s more.
Stock investors aren’t just a little reluctant to acknowledge that what Shiller has shown is so really is so. A good percentage of stock investors hotly oppose even discussion of Shiller’s ideas. A Buy-and-Holder who is willing to engage in good-natured discussion of the far-reaching implications of Shiller’s amazing research findings is a rare find. Most investors are not just unconvinced of the reality of irrational exuberance. They are downright threatened by the thought that there might be something to it.
I believe that there’s another term that we could use: Dishonest exuberance.
It’s a harsher term. To tell investors that they are guilty of irrational exuberance is akin to telling them that they are guilty of falling head-over-heels in love. Perhaps it is not entirely a sensible thing to do. But the phrase suggests behavior that is at least to some degree charming. That’s not so with “dishonest exuberance.” That sounds ugly, nasty. Dishonesty hurts people. To call what is going on when stock prices rise to the levels where they reside today “dishonest exuberance” is to make a moral judgment. It is to tell investors that they are doing something bad. It shouldn’t be too surprising that they react negatively to such an accusation.
I’ve never heard anyone else use the term “dishonest exuberance” when referring to the stock overpricing phenomenon. But I think that is what a good number of Buy-and-Holders hear when the softer term is employed. The reality is that to bid stock prices up to price levels that cannot be sustained IS dishonest. Using soft terms to describe the phenomenon does not fool anyone. When we talk about setting stock prices at unmerited levels, we are talking about dishonesty. It’s not a fun escapade. It’s the perpetuation of an untruth that always ends up hurting lots of people in very serious ways.
Irrational exuberance/Dishonest exuberance hurts people. Effective financial planning becomes impossible when investors don’t know the true and lasting value of their portfolio. The continued viability of businesses is put into jeopardy when they expand because of projected earnings that are likely not going to materialize because the projections were rooted in spending patterns caused by inflated portfolio numbers. Irrational exuberance/Dishonest exuberance takes money out of the hands of those who do not yet have enough working years behind them to have large investment accounts and puts it in the hands of older workers. That’s not a fun idea. We would think of it as a mean-spirited idea if we were thinking about it clearly.
The last thing we need in the investment advice field is more antagonism between the Buy-and-Holders and those who have grave doubts about the wisdom of price-indifferent investment strategies. So I am not suggesting that the term “irrational exuberance” be replaced with the term “dishonest exuberance.” However, I don’t think that it would be a bad idea to reflect from time to time that what is going on is not as playful as the softer term suggests. Irrational exuberance is a dishonest, mean-spirited thing. If we are going to eliminate it from the stock investing experience, we are going to need to come to terms with that reality.
Rob’s bio is here.