The Same Forces That Explain Bull Markets Explain the Suppression of Discussion of Shiller’s Research Findings

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Buy-and-Hold is nothing new. The term is relatively new. But the idea has been around for as far back as there has been a stock market to invest in. The core idea is to practice price indifference. That’s a dangerous idea.

Buy-and-Hold investing is Get Rich Quick investing – as irrational exuberance is created, investors are encouraged to do nothing about it, to disdain market timing. There’s no other way to rein in irrational exuberance except through market timing. When Buy-and-Hold becomes popular, the stock market becomes a car without brakes. Everyone loves the pretend gains generated through irrational exuberance and no one feels a need to do anything to rein it in. The belief that market timing is not needed makes it impossible for irrational exuberance to be overcome by anything other than a price crash and an economic collapse.

I am not a fan. I do love everything that the Buy-and-Holders say about how stock investing works except for the claim that market timing is not an essential part of the story. I believe that Robert Shiller’s focus on irrational exuberance is well-placed. I am the co-author (with Wade Pfau) of research showing that most of the risk of stock investing is rooted in the failure of most investors to practice market timing/price discipline. If investors just lowered their stock allocation whenever prices increased their risk profile to a significant degree, prices could never get too out of hand and we would no longer need to worry about bull markets or bear markets or price crashes or the economic collapses that follow from them.

Taking Shiller’s research findings seriously

I’m always trying to come to a better understanding of why Shiller’s amazing research showing that valuations affect long-term returns has had so little effect on the stock-buying habits of most investors. Shiller was awarded a Nobel prize in Economics. So in one sense his research has had a significant impact. But you wouldn’t know it by looking at today’s CAPE level. If we took Shiller’s research findings seriously, we would not have collectively agreed to price stocks at two times their fair value. We value Shiller’s achievement and ignore it at the same time.


Ignoring the price of stocks when buying them is an inclination rooted deep in human nature.

I believe that this is a self-destructive inclination. It is akin to the inclination to drink alcohol to excess or to the inclinations that cause people to become romantically involved with people who are not good matches for them or to the inclination to drive a car at an unsafe speed. Humans have been known to behave irrationally, to do things that cause themselves harm. It’s the oldest story in the book. Shiller’s insight was to see that the universal human inclination to engage in self-destructive behavior plays a big role in the stock investing story.

I would like to see us all engage in greater efforts to overcome our unfortunate tendency to overprice stocks from time to time. On the surface, it does not seem like this should be a hard case to make. If we priced stocks properly at all times, we would earn an annual return of 6.5 percent real. Isn’t that good enough? Most of the risks that people think of as being associated with this asset class would disappear if we simply elected to better police our Get Rich Quick urges. Why don’t we just do that?

I think it’s hard to not take the numbers that appear on our portfolio statement seriously. Those numbers are the official value of stocks at a given time. They are decided on by millions of investors working together to assign a price to their stock holdings. Shiller’s research challenges us to see through the official numbers and to recognize that the portion of the official price that reflects the effect of irrational exuberance (the portion that pulls the CAPE value above its fair-value level of 17) is temporary and emotion-based and, frankly, a bit of a fraud. We should not make any plans based on a belief that that portion represents something real.

But we want to! Nothing could be more clear.

Market timing doesn’t work

I think it helps to adopt a broad perspective when thinking about these matters. Prices have never been more out of control for a longer stretch of time than they have been in recent decades. That’s disheartening. But we have very much been struggling to arrive at a deeper understanding of these matters during that time. In one sense, the widespread promotion of the Buy-and-Hold concept has made matters worse. Today’s investor feels virtuous disdaining market timing/price discipline. There’s research showing that market timing doesn’t work, don’t you know?

That’s only a surface understanding of what is going on, in my assessment. There’s another respect in which the popularity of Buy-and-Hold is a very positive sign. The research that is said to show that market timing doesn’t work applies only to short-term timing, the thing where investors try to guess when price shifts will take place, which really doesn’t work, for obvious reasons. The research shows exactly the opposite, that valuation-based market timing always works and is always of critical importance. I believe that in time, probably in the days following the next price crash, investors will catch on to that reality and the idea that investors should be guided by peer-reviewed research will begin paying off for all of us in a big way. It was the Buy-and-Holders who planted that idea in our brains.

When Shiller encourages us to do battle with irrational exuberance, he is urging us to do something that has been foreign to the spirit of most stock investors since the beginning of time. That’s why it has taken so long for his ideas about stock investing to catch on. But the full reality is that progress is being made every day. We are over time coming to acceptance of an understanding that we should drink only in moderation and pay attention to red flags when dating and obey posted speed limits and practice market timing as needed. We are gradually and ever so slowly arriving at a better understanding of this important subject matter.

Rob’s bio is here.