Think what it means for irrational exuberance to be a real phenomenon, as Robert Shiller’s Nobel-prize-winning research shows to be the case. Before Shiller, many economists believed that the market is efficient.
That would mean that investors act rationally in pursuit of their self-interest and thereby insure that the market always gets prices right. Shiller showed that that is not so. Investors are not rational! The market is not efficient! Prices are not right!
Q4 2022 hedge fund letters, conferences and more
Pushing Stock Prices Higher
Investors must be at least somewhat rational. If they were not, the mispricing would continue forever. In fact, it would get worse over time. Investors misprice stocks for the same reason that bank robbers rob banks – that’s where the money is. When we push stock prices higher than they should be, it’s as if we are all voting ourselves raises. Why wouldn’t we do that?
But we don’t do it forever. We push stock prices up and up and up and then – down? We eventually push stock prices back down. Irrational exuberance is a temporary phenomenon. Why do we do this crazy thing that seems to run so counter to our self-interest?
We push stock prices down because, just we all possess a Get Rich Quick urge within us that is drawn to the idea of obtaining something for nothing, we all also possess a desire to live within the dictates of common sense and there is something about irrational exuberance that just doesn’t satisfy in the long term.
The Buy-and-Holders were wrong to think that we are perfectly rational creatures. But it would be equally wrong to think that we possess no rationality whatsoever. We possess enough rationality to crash prices when they have gone too high for too long for us to believe that the situation is sustainable.
It is stock investors who crash stock prices. No one else. We do it to ourselves. We hate it when it happens. But we are the ones in charge of stock prices. We cannot point the figure at anyone else.
It cannot be that we only become aware that stocks are improperly priced in the moment before prices crash. The part of our brain that is able to detect mispricing does not magically come into operation in that moment. It’s always there. We don’t listen to it during a bull market. But it must be present. Which means that –
During those years when we are pushing stock prices up, up, up, we know that we are wrong to do so. That’s an amazing thought, isn’t it? We know it’s wrong and we do it anyway. Isn’t that just like the humans?
I have noticed something during my travels on the internet. Investors get very uptight when you start talking about the how-to implications of Shiller’s research. People don’t mind too much if you just mention Shiller’s name or if you bring up his Nobel prize and then move on to some more pleasant subject.
But you are not going to win popularity points telling people what their stock portfolio will be worth after prices have made the return trip to fair-value levels. Information denied! Insight unwanted!
How Defensiveness Works
You know how defensiveness works. There is nothing that gets a person more angry than to hear about a mistake he made of which he is already aware. Tell someone that the movie that he was planning to see tonight does not come out for another week and he will thank you for setting him straight.
People like to be spared confusion. But tell him that he chose the wrong career because jobs in his field are dead ends and he may blow up. Because that thought has been pressing on his brain for some time now and he has been trying to ignore it.
Stocks are priced for a crash today. If that’s so, then I am helping you by giving you a chance to lower your stock allocation before it hits. But you know it is as much as I do. Shiller’s research findings are not a secret.
You can find out the CAPE value any time you please by entering a simple search into the Google engine. You don’t want it to be so. You don’t want to believe it. You wish that I would give it a rest. I hear it all the time.
Can this ever change? Could there ever be a time when people consumed information on the dangers of overpriced stocks with the same enthusiasm with which they consume information on all the other ways to add to their fortunes? I think we can get there.
I think it would be a breakthrough. For it to happen, we need to better understand the investor psychology that causes us both to know things and not to know things at the same time.
The things that cause a bear market are present even during the times when the bull market is super hot. They are not visible on the surface. But they are lurking on a deeper level of consciousness. We need to figure out how to better see that stuff that we think we don’t want to see but that in reality we very much need to see.
Rob’s bio is here.
