Valuation-Informed Indexing #403
By Rob Bennett
Robert Shiller argues that there is a phenomenon that he calls “Irrational Exuberance.” When he uses that term, he does not mean to suggest that one or two or three or one or two or three thousands of us go a little crazy during a bull market. He means that we go collectively crazy during a bull market. Even those who have doubts about the bull market prices keep quiet about their doubts. They are warned that, if they speak up, they might cause prices to crash and thereby hurt millions of people. No one wants to do that. So we all either encourage the bull or keep quiet about our doubts about it.
It’s hard to overstate how pervasive the irrational exuberance phenomenon becomes. I have had four different economics professors discover my web site and become sufficiently impressed by the materials housed at it to contact me and tell me that they intend to incorporate my ideas about how stock investing works into their course materials. Huh? I was obviously honored to be told that on each occasion that it happened. But it really should never happen. I never studied investing in school. I never managed a mutual fund. How did I ever come to learn things about how stock investing works that many of the recognized experts in this field do not understand? It’s that irrational exuberance phenomenon at work again. It hurts me because it makes people skeptical about my claims, which are advanced by few others. But it permits me to gain sole access to lots of powerful insights that I would be fighting over with lots of competitors if we were all thinking clearly about these matters.
I have never been as shocked in this lifetime as I was on the day in May 2003 when I was banned from the Motley Fool web site. I was at one time the most popular poster at the entire site (during a time when I wrote only about saving strategies and never about investing). The owner of the site was so impressed by a report that I wrote on “Secrets of Retiring Early” that he wrote a gushing review of it that appeared on the front page of the site. I was invited by the site to be a paid instructor for its online retirement course. I was the primary person responsible for building up the most successful discussion board in the site’s history. And I of course never violated a single published posting rule even one time. And I was banned! That’s irrational exuberance!
I came to see in time that it has to be that way. Say that Motley Fool (and all other investing sites — I have been banned at most of the big ones!) enforced its published posting rules in a reasonable manner. If that happened, stock prices could only rise so high, irrational exuberance could only become so pervasive. If all of us who have spent time thinking through the far-reaching implications of Robert Shiller’s research could inform millions of people of a better way to invest their retirement money, those people would refuse to take on the risks associated with investing heavily in stocks at times of crazy high prices. Which would mean that — the prices would not remain crazy high for long! When people come to see irrational exuberance for what it is, it disappears. Illusions work only until we gain the power to see through them.
There is no research supporting the Buy-and-Hold investing strategy.
Did you know that? I sure didn’t at one time in my life. I was once a Buy-and-Holder myself. The thing that I liked about the strategy was that it was research-based. I didn’t want to invest my retirement money pursuant to some fellow’s opinion on how stock investing works. I wanted the hard stuff — peer-reviewed research. I was told that Buy-and-Hold had it, so I became a Buy-and-Holder. Then I came to notice some cracks in the paint job and pushed a bit to see what was behind them and saw my entire wall of belief come crashing down. If you dig deep, you will discover that there is no research supporting the Buy-and-Hold strategy.
There are many good and smart people who say that there is research. They are not liars. They believe what they say. But the research that they believe in just does not happen to exist.
The story that I am telling sounds incredible, even to me. How could there be many smart and good people saying that there is research that does not exist? It’s that old irrational exuberance phenomenon working its spell again.
Eugene Fama really did produce research showing that short-term timing does not work. That’s the research that people are talking about when they say that Buy-and-Hold is a research-based strategy. And it is fine research indeed. Fama was awarded a Nobel prize for that research. His research showing that short-term timing does not work is one of the most important findings in the history of our effort as a people to come to intellectual terms with this stock investing thing.
But Fama’s research does not show that long-term timing (changing your stock allocation in response to big valuation shifts with an understanding that you may not benefit from doing so for as long as 10 years) does not work. Fama did not even look at long-term timing. Shiller was the first to do that. He showed that long-term timing always works and is always required for investors seeking to maintain roughly the same risk profile over their investing lifetime. For Buy-and-Hold to work, both short-term timing and long-term timing would need to be futile endeavors. And there is simply no research showing that. The idea that there is such research is an illusion, an illusion that did not just by coincidence become very popular during the most out-of-control bull market in our nation’s history. We need to believe that there is research supporting Buy-and-Hold to maintain our belief that the prices generated by our irrational exuberance are real and so we do.
Irrational exuberance is a killer. To become irrationally exuberant is not to believe one thing, it is to believe many things, each of them an essential part of the illusion created by the overall phenomenon that crazy prices generated by out-of–control investor emotions possess lasting economic significance. We have to believe in all aspects of the illusion to maintain confidence in the overall story. And so we come to believe in lots of wrong things when we fall victim to the irrational exuberance disease. Irrational exuberance is a pervasive phenomenon.
Rob’s bio is here.