There’s a famous quote attributed to John Maynard Keynes – “Markets can remain irrational longer than you can remain solvent.” Is it so?
Pretty much. Robert Shiller published a paper in 1996 warning Buy-and-Holders that, if they stuck with their high stock allocations despite the high stock valuations of the day, they would come to regret doing so within 10 years. 28 years have passed and the Buy-and-Holders have not cried “uncle!” The CAPE value is higher today than it was in 1996 and prices have remained high for the entire 28 years except for a few months in the immediate wake of the 2008 price crash. According to the Buy-and-Holders, it’s the Valuation-Informed Indexers who should be feeling regret.
I do not feel regret. I feel surprise. I feel shock. I feel dismay. If I you had told me in 1996 how stock prices would have played out over the course of the following 28 years, I would have said that it wasn’t possible. What happened is not possible. But it happened all the same. We need to acknowledge that. Investors need to know that. The Buy-and-Holders got that one right and Shiller got that one wrong.
Except….
I don’t believe that that is entirely so.
Prices have been super high for a super long time. So Keynes was getting at something important. What I don’t like about his claim is that a lot of people use it as a rationalization for defeatism. People can see that today’s prices are crazy. It worries them to have their retirement money invested in an asset class whose value is determined by a market that behaves in crazy ways. Ordinarily, their concern would prompt some sort of action. But they recall to mind the Keynes quote and they console themselves that there really is nothing that can be done.
That rubs my fur the wrong way. Something must be done! I cannot accept irrationality when it comes to the investment of my retirement money. I believe that something must be done. So I feel compelled to dig a little deeper into the implications of the Keynes observation.
We are the market. Investors make up the market. Saying that the market has been irrational for a long time is another way of saying that we have been irrational for a long time. We can of course do things about that. Humans have been known to evidence irrationality in lots of areas other than stock investing. I cannot think of another area where we tell ourselves that it’s okay just to continue with the self-destructive behavior. When we see reckless driving, we create public service commercials advising people not to use cell phones when driving. When we have loved ones drop dead from heart attacks, we ask the doctors if there are changes we could make in our diet to avoid suffering the same unfortunate fate. In areas other than stock investing, we understand that irrationality hurts us. So we make an effort to rein it in.
Why is stock investing different? Most of us see the stock market as this big complicated thing out of our control. Most of us are intimidated by it. So, when we think we see the market behaving in dangerous ways, we keep it zipped. Perhaps we are not seeing things properly. People smarter than us think that Buy-and-Hold strategies are just fine. We don’t know enough to speak up.
I believe that our instincts are good. I believe that we need to speak up. I believe that the stock market is messed up. To use Keynes’ word, it is irrational. And, yes, it’s been irrational for a long time. That’s a bad thing. We shouldn’t take the Keynes observation as a justification for not taking action. We should take it as a warning that taking action is critical. Yes, the market can remain irrational for a long time if we fail to take action. So let’s be sure to take effective action before things get too out of control.
The Buy-and-Holders have a phrase they employ when the market remains irrational for a long time. They say that those who lowered their stock allocation because of concerns over the craziness missed out. Looking only at surface appearances, they did. Prices remained high or went a bit higher and the Valuation-Informed Indexers lowered their stock allocation. They could have participated in those gains and they did not. They missed out.
But wait.
Shiller had a name for the phony gains, the gains that were the product not of economic productivity but only of investor emotion – irrational exuberance. Those who lowered their stock allocation only missed out on irrational exuberance! Is that such a bad thing? It sounds to me that irrational exuberance is something that you would want to miss out on.
The Buy-and-Holders are begging the question when they play the “missing out” game. They use the official numbers for stock prices to make their case. They act as if the gains achieved at times of crazy high prices are real. But of course that’s the entire question in controversy. Shiller’s research showed that those gains are not real, they are phony and temporary. So missing out is not really a possibility. You cannot miss out on something that is just empty air, that does not really exist. Irrational exuberance is empty air, is it not?
I need to be careful here. Stocks are an amazing asset class. When one lowers one’s stock allocation, one really is missing out on an opportunity to participate in the benefits of an amazing asset class. So I believe that the reality expressed in the Keynes quote should be kept in mind when one determines how much to lower one’s stock allocation in response to high stock prices. Getting entirely out of stocks is not generally a good idea. Dramatic allocation shifts are a dubious choice.
But to make no allocation adjustments whatsoever, to disdain market timing altogether, is to contribute to the irrationality. That’s going too far. I see the Buy-and-Hold strategy as a marketing gimmick. There is no support in the peer-reviewed research for a policy of disdaining market timing altogether (I have checked!). I believe that the experts who discourage market timing are trying to make their clients feel good about their irrationality by suggesting that efforts to take things in a more reasoned direction would prove futile. I believe that rationality always pays off in the long run. And, yes, I’ve checked on that one too and the historical return data shows that it is indeed so.
The market can remain irrational for longer than would seem possible. But investors have the power to move it in a better direction. And they will see rewards for doing so if they only stick to their guns and keep their heads even when many they see around them are losing theirs.
