All Discussions of Stock Investing Should Acknowledge That There Are Two Schools of Academic Thought re the Basics
Shiller changed everything that we once thought we knew about stock investing when he published research showing that valuations affect long-term returns. This finding was a “revolutionary” (the word appears in the subtitle of Shiller’s book) advance. It was because of this finding that Shiller was awarded a Nobel prize.
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Q4 2021 hedge fund letters, conferences and more
Alkeon Sees High-Quality Growth Stocks Getting Scarce
Alkeon Growth Partners was down 10.15% for January, compared to the MSCI World’s -5.34% return and the MSCI AC World’s 4.96% decline. Since its inception, Alkeon has returned about 2,000% or 13.48% on an annualized basis. The MSCI World is up 226.62% for an annualized return of 5.04% since Alkeon’s inception, while the MSCI AC Read More
Stock Investing Risk
What’s the big deal? The big deal is that, if valuations affect long-term returns, stock investing risk is not stable but variable. Stock investing risk varies with shifts in valuation levels. Investors who want to stay the course in a meaningful way need to engage in market timing to do so. They need to adjust their stock allocation in response to changes in valuations to keep their risk profile stable.
Most investment advisers act as if Shiller’s research didn’t exist. He is a respected figure. But I am not able to identify one way in which the investment advice that was offered in the days before Shiller published his research has changed since it became available. Not surprisingly, the CAPE level has not come down as a result of the publication of Shiller’s research. It has actually increased. We have seen higher CAPE values remain in place for longer periods of time in recent decades than we have ever seen before.
Many people who work in this field would like to be advising investors to lower their stock allocation in response to super high CAPE values. I know because I have spoken to a good number of them. Most do not want to be entirely public about it. Recommending market timing is a controversial business in today’s world. But experts see the need to begin taking Shiller’s amazing contributions more seriously. And many investors are open to hearing such advice.
But strategies that call for market timing for the purpose of keeping risk constant over time remain unpopular. The problem is that the promotion of such strategies makes Buy-and-Holders uncomfortable. The Buy-and-Holders of course remain the majority. And of course that will always remain the case for so long as the advocates of valuation-informed strategies remain reluctant to make the case for their beliefs in clear and firm and bold ways.
The Buy-And-Hold Model
I believe that the answer is for all who work in the field to work for the formation of a consensus that there are today not one but two academic models for understanding how stock investing works. There is of course the Buy-and-Hold Model, which remains dominant. And since the publication of Shiller’s research, there is a second model, the model rooted in Shiller’s research findings, Valuation-Informed Indexing.
I am the person who ascribed that name to the Shiller model. Incredibly, Shiller has never given his model a name. I have written extensively about the Shiller model and felt the need to have a name by which to refer to it. So I came up with a name. Why didn’t Shiller or some other advocate of his beliefs come up with a name long before I came on the scene?
It’s that same basic problem that people feel that to even mention that there is today a second academic model is to suggest that there is something wrong with Buy-and-Hold. Shiler’s research does indeed suggest that there is something profoundly wrong with the Buy-and-Hold model. Both models cannot be legitimate. If the market is efficient, as academics believed in the days when Buy-and-Hold was being developed, it is not possible that valuations affect long-term returns. If valuations affect long-term returns, it is not possible that the market is efficient.
People make mistakes. People get things wrong. I think we all need to be frank about the mistake that was made by the Buy-and-Holders in the days before Shiller published his research. I have never seen any evidence that the mistake was intentional. It was just one of those things. And of course the Buy-and-Holders made many important contributions that have stood the test of time. So the mistake should not be the cause of any embarrassment.
However, the failure to acknowledge the possibility that the Buy-and-Holders got some important things wrong should be the cause of embarrassment. If Shiller is right, market timing works. If Shiller is right, market timing is required. Investors need to know that. Most do not today know this because most who work in this field are hesitant to speak in frank terms about the mistake made by the Buy-and-Holders.
A Dangerous Practice
It is a dangerous practice to keep quiet about these matters. The obvious problem is that it puts investors in danger or suffering big losses. It also puts our economic system in danger of a collapse as the collective losses that would likely be suffered in a price crash would reduce consumer spending by trillions of dollars. And the reputations of the Buy-and-Holders will be greatly damaged in the event that we see a price crash of the size that we should expect if indeed most of the value of today’s stock market is rooted only in irrational exuberance and not in anything of real economic substance.
The vast majority of investors retain trust in the Buy-and-Hold Model today. It is not realistic to expect them to give up that belief until the model is challenged in a serious and extensive and sustained way. My guess is that we will not see effective challenges raised until the days following the next price crash. But I think that we should today be making preparatory steps toward the launching of the grand national debate that will be held at that time by reminding investors that there are today two models, not one, and that all strategic advice offered pursuant to the Buy-and-Hold Model depends on the legitimacy of that model. Putting things that way at least serves to put some doubt in the minds of the investors hearing the advice.
Rob’s bio is here.