I remember reading the article on the front page of the New York Times reporting on how Robert Shiller and Eugene Fama had both been awarded the Nobel prize in Economics on the same day. The article observed that it was odd that two people with opposing views on how stock investing works would both receive the highest honor in their field for their work.
It certainly was odd.
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Understanding How Stock Investing Works
The other side of the story is that I believe that both Shiller and Fama merited the award. Shiller’s research revolutionized our understanding of how stock investing works. So I feel no hesitation in saying that he deserved to be recognized with a Nobel prize.
I don’t feel as strongly about Fama’s research showing that short-term market timing does not work. But I believe that that was a highly important advance. So I think it made sense to give them both the award.
What doesn’t make sense is that as a nation of people we have not for the 41 years since the publication of Shiller’s research done the work needed to resolve the apparent differences between Shiller’s research and Fama’s research.
It’s not too difficult intellectually to do so. The thing that is holding us back is that doing so would bring on an enormous change in the how-to investing advice that we offer to millions of people and the experts who have been promoting the approach that became popular in pre-Shiller days are extremely reluctant to acknowledge that because that research was not available to them at the time they developed their strategy (Buy-and-Hold) that got some important things very wrong.
Fama showed that short-term price movements are unpredictable. So of course short-term timing does not work. Shiller showed that long-term price movements are highly predictable (stock valuations always move in the direction of the fair-value CAPE level of 17). There was never any evidence that long-term timing is not required.
It would be extremely strange if there were since investors who fail to engage in long-term timing are failing to exercise price discipline and it is the exercise of price discipline that permits all markets to perform their essential task of setting prices properly But, since the experts did not have access to Shiller’s research at the time the Buy-and-Hold strategy was being developed, they jumped to the unfortunate conclusion that no form of market timing works or is required.
That’s like concluding that, because drunk driving is dangerous, no one should ever get behind the wheel of a car! Our economy would obviously be a great deal less productive if we all gave up the driving of cars.
But the equivalent of that happened in the stock investing realm when the idea became popular that long-term market timing is not always 100 percent required for all stock investors. Without market timing to reset prices when irrational exuberance threatens to get out of control, prices get so high that we eventually see a price crash and the economic contraction that follows from the huge loss of consumer buying power.
The Fama Vision And The Shiller Vision
If only we could go back to the 1960s, when Buy-and-Hold was being developed based on Fama’s research findings, and play this one over! My belief is that, if we did that, we would all agree that market timing is absolutely required for all investors and we would never again experience the crazy prices that have applied in recent decades. But that is of course not a practical option.
I come at these issues from the perspective of a journalist, not an investment expert or an economist. I view this matter of the conflict between the Fama vision of how stock investing works (no form of market timing is a good idea) and the Shiller vision (short-term timing is a bad idea but long-term timing works and is required for investors who want to keep their risk profile constant over time) as the most important public policy issue before us today.
If Shiller is right that a large portion of today’s stock market wealth is only the product of irrational exuberance and has no lasting economic significance, we are due for a difficult reckoning with the stock market realities in the not-too-distant future.
We should be talking about it. Everywhere. All the time. The only way to figure out the realities and to come to have confidence in the conclusion we reach about them is to seek input from lots of smart people coming at these questions from all sorts of angles.
When the New York Times point out that it was odd that two people with entirely different visions of how the stock market works were both awarded a Nobel prize for their work on the same day, my reaction was that surely people all over the country would read those words and launch the national debate that we need to have on the next morning.
That of course has not happened. My sense is that we feel too much shame over the long delay that we have tolerated in the launching of that debate to go about the launching of it today.
So the conflict remains. Shiller and Fama cannot possibly both be right. Every investor in the United States needs to know which of the two of them nailed it and which of the two of them got at least one important aspect of the stock investing question terribly wrong.
Further delays in the launching of this critically important debate serve no good purpose whatsoever. Further delays just deepen our feelings of national shame.
Rob’s bio is here.
