Robert Shiller showed with his Nobel-prize-winning research that irrational exuberance is a thing. Back in the days when the Buy-and-Hold strategy was being developed, there was a widespread academic belief that the stock market was efficient. If that were so, investors would make rational choices, and neither overvaluation nor undervaluation would be possible. Shiller showed that the market is inefficient, that investors are often highly irrational, and that valuation-based market timing is needed to pull prices back to reasonable levels when they get out of hand.
But we don’t talk about it.
If you went by what is said about stock investing in the year 2024, you would think that Shiller’s research didn’t exist. Today’s CAPE level is 37. That’s more than double the fair-value CAPE level of 17. So we are in a scary place. A price drop just to fair-value levels would cut the value of millions of stock portfolios in half. That would be a collective loss in the many trillions of dollars. A loss of that much consumer buying power would obviously translate into an economic collapse. How did it happen?
It’s the most natural thing in the world. All investors want their portfolio value to be higher. They have the power to bid up stock prices and thereby make it higher. So they do that. They’ve been doing it since the first stock market opened for business. They don’t bid up stock prices quickly. That would be too obvious. Irrational exuberance won’t be taken if people can see what’s happening. They do it gradually. Year by year, prices get more out of control until one day, the CAPE value is 37, and we are all in a terrible fix.
Is there any way to stop it? There’s a very easy way. We could talk about what’s happening while it is happening.
Every investor wants to get the best deal he can get from his stock purchases. The long-term value proposition of stocks is obviously diminished when prices are high. Investors who were regularly reminded of that would go with lower stock allocations when prices were high. So they would never get too high. Higher stock prices would generate stock sales, and the stock sales would pull prices back to reasonable levels. Stock prices are self-regulating in a world where most investors are regularly reminded of Shiller’s amazing research findings.
That’s not the world we live in. Most of us like high stock prices. We cheer on price jumps. Since we like Pierce jumps so much, the people who advise us on investing don’t talk much about the price crashes that inevitably follow from CAPE values like the one that applies today. So we are able to push those thoughts to the back of our minds.
The alternative to talking about the dangers of high stock prices and taking action to get them back to reasonable levels again is Buy-and-Hold. Buy-and-Holders say that there’s no need to engage in market timing. They don’t directly say that high prices are good. They say that there’s no need to do anything about them when they get out of control. If investors really were rational, that would follow. However, the reality is that investors are often highly irrational, and the only way to keep the irrationality from getting out of control is to encourage market timing. To fail to do so, given what has happened on earlier occasions when prices were permitted to get out of control, is reckless and irresponsible. Buy-and-Hold is a reckless and irresponsible investment strategy.
Most stock investors do not practice market timing. But most are entirely open to it. I believe that most investors would engage in timing if they were regularly encouraged to do so by the experts in this field. Most investors feel intimidated by the stock investing project. They don’t believe that they know enough about the subject to ensure they are not making mistakes when investing their retirement money. So, they are disinclined to do the opposite of what most experts say. For so long as most experts discourage market timing, most investors are not going to engage in it.
But most are open to it. I have been writing about the need for investors to engage in market timing for many years now and I can tell by the questions that I have seen directed at me that most investors possess a genuine interest in coming to a better understanding of the matter. They don’t like to hear that their portfolio has a much smaller real value than what they have been led to believe it has. So this is a delicate matter. They will stop listening if too much is put before them all at once. Their strong preference is to believe in Buy-and-Hold. Market timing is not something they embrace. But most are not entirely close-minded on the question (some are, to be sure).
So this is an unusual matter where talk alone would solve a very big problem. Irrational exuberance brings on bull markets, which bring on price crashes. Price crashes bring on economic collapses and a lot of human misery, all of the unfortunate aspects of stock investing. All of that is optional today. In the post-Shiller era, all that we need to do to eliminate irrational exuberance is to talk about it. It’s not something that will happen tomorrow or later in the week. But I believe that this fortunate turn of events is the future. I believe that the onset of the next Buy-and-Hold Crisis will bring on a desire for change strong enough to get a healthy conversation going.
