The Stock Market Is Uniquely Structured to Encourage Self-Deception

Stock investing is a cereal business.

No! No! It is a serious business. Why did I say it that other way?

Because we do not take it entirely as a serious business. We engage in a lot of self-deception when buying stocks. I think that we need to work on overcoming our inclination to do that.

Robert Shiller published research showing that valuations affect long-term returns and published a book exploring the dangers of creating too much irrational exuberance. We blew him off. We continued buying stocks in the same old Buy-and-Hold way and pushed the CAPE value to 32. We’re not a serious people.

Why? We should be. We all care about financing secure retirements.

Stocks encourage self-deception

The trouble is the nature of the asset class. Stocks are uniquely structured to encourage self-deception.

There is no other asset class for which the owners of the asset class determine how much it is worth. There’s an extent to which that is so with houses. The owners of houses collectively determine how much houses are worth. But people don’t buy and sell houses regularly. When people hear that the value of their house has increased, they are fascinated to hear that but they don’t think of it as information that they can cash in on at anytime in the near future. People think of increases in the price of stocks as gains in the current day. When they hear that their portfolio is valued at a higher price, they think of themselves as being richer than before in a concrete and immediate way.


It’s dangerous for the owners of an asset class to possess the power to assign it its worth. The owners possess an obvious bias. The people who own stocks want stocks to be priced higher. So they direct a good deal of mental energy to the project of pumping up the price. There are all sorts of rationalizations available to the human mind engaged in this task.

Market timing. That’s the only possibility. Improper price increases always disappear into the mist in time. The people who buy stocks could remind themselves that stocks do not perform as well when purchased at higher prices and to therefore elect to go with smaller stock allocations at such times. That would pull prices down when they need to be pulled down. Stock prices are self-regulating in a world in which information can be freely shared about how excessive price increases affect the value proposition of stocks.

But rationalizations come to the rescue once again. What if most of us came to believe that market timing is not really necessary, that there might be something bad and yucky and unwise about it? In that scenario, irrational exuberance would always win. We all want stock prices to be higher and we would all engage in all sorts of creative rationalizing to make the dream come true.

 A dangerous investment class

Stocks are a great investment class. But they are a dangerous investment class. It is asking a lot to ask the human stock investors not to bid prices up to very high levels. Then when they come down, trillions of dollars of consumer spending power is destroyed in a flash. That translates into economic collapse. Has there ever been a strong bull market that was not followed by a dark economic downturn? That’s a rhetorical question.

I think that investment advice should be built around helping people to avoid the core danger of stock investing. It’s an investment class that entices us into massive acts of self-deception. What if the experts focused our attention on the CAPE value on a daily basis? What if they informed us of how many trillions of dollars of wealth would be destroyed in the event that stock prices returned to fair-value levels, as they have at every earlier time in history in which they rose so high? What if they translated the numbers into portraits of human misery, telling us how many millions of failed retirements we were likely to see and how many millions of people were likely to be thrown out of work in the economic collapse resulting from the destruction of so much wealth?

I am proposing a revolutionary change in how we all talk about stock investing. No more rah-rah stuff about the creation of irrational exuberance, acting as if pretend gains were something to celebrate. A focus on keeping stock prices real, a desire to keep them as close to fair-value as possible.

I’m a dreamer. Or maybe just a lunkhead. One of those in any event, that’s for sure.

Rob’s bio is here.


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