Robert Shiller’s research brought on a “revolutionary” (this word appears in the subtitle of Shiller’s book) advance in our understanding of how stock investing works. But few people appreciate that advance. If they did, the amount of irrational exuberance (the title of Shiller’s book) present in the market price would be smaller than it had ever been before. The reality is just the opposite. We have seen more irrational exuberance in the past 25 years than at any earlier time in U.S. stock market history. We are as a people are doing an amazing job of ignoring the powerful insights that Shiller brought to the table.
Our Get Rich Quick Urge
The problem is that Shiller’s message is one that most of us very much do not want to hear. Stocks are today priced at two times their fair value. If we were to adjust the number on our stock portfolio statement to reflect the research-demonstrated realities, we would have to divide that number by two. Very few of us can bear to do that. So, the vast majority of us goes about stock investing as if Shiller’s Nobel-prize-winning research did not exist.
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I often explain our reluctance to embrace Shiller’s research findings by arguing that we all possess a “get rich quick” urge within us. We don’t pay attention to Shiller because we like the idea of getting something for nothing. So long as we can convince ourselves that the market is efficient (that investors set stock prices rationally), we can pump stock prices up to crazy levels and treat the resulting increase in our accumulated life savings as real and lasting money. In the short term, creating irrational exuberance is a lot of fun.
I think that all of that is so. But I also believe that that simple explanation does not quite explain the ferocity with which I have seen many buy-and-holders reject the idea that irrational exuberance is a real phenomenon and that stock gains beyond those supported by the fair-value CAPE number of 17 are not real. We of course all possess common sense as well. If all that we were dealing with was the get rich quick urge, our desire to live our lives in accord with the dictates of common sense would block us from permitting stock valuations to get as out of control as they are today.
The Value of Our Stock Portfolio
There’s something else at play. That something else is the feeling of well-being that a high portfolio value provides us re: the level of success we have achieved in living our lives. We all want to know that we have made good decisions, that we have done well. There are a variety of signifiers that we look to for reassurance that this is the case. We take comfort in having family members and friends who admire us and in obtaining promotions in our career and having the material possessions (a house, a nice car) that send a message to the world that “this person has overcome the obstacles that all people face in life and has made something of himself or herself.”
We look at the number revealing the value of our stock portfolio that way. That number is the score in the baseball game. We of course know about the effort that went into the playing of the game, the intelligent strategies that were executed, the daring dives for the ball that turned what might have been a double into an out, the times we nearly felt the pain of getting hit by a pitch because we were crowding the plate to gain an edge over an intimidating pitcher.
Our brains cannot keep all of those reassuring data points in mind at one time. Our brains look for the shorthand version of the story – the score. If the score is good, we feel that we are good. In life, the portfolio value is the score of the game. If you have accumulated more than the portfolio value that you believe you should have accumulated by the stage of life at which you stand, you feel a sense of well-being that is deeply satisfying.
Shiller’s research findings threaten to take that away. Shiller is of course trying to help us. It is better that we know the true value of our stock holdings. We need to know the true value to engage in effective financial planning. Shiller’s entire contribution was to help us do that. But the present-day reality is that a message that we need to divide the number on the portfolio statement by two is a painful message. It means that we have not been as successful in the management of our life affairs as we have been led to believe we have been.
It’s Not Just About Money
The point here is that it’s not just money at stake. It’s so easy to proclaim, “Oh, everyone should want to know the real numbers.” As a matter of logic, that’s of course so. But we are all emotionally vulnerable people. It comes as an emotional shock to hear about research suggesting that we have not gotten as far in life as we had come to believe was the case. Shiller’s research makes it hard for investors to engage in self-deception. Sometimes, self-deception is a soft place to land in a world filled with too many hard tumbles.
I am sympathetic to investors who close their ears to Shiller’s message. However, the other side of the story is that investors who do not come to terms with their self-deceptions by taking Shiller’s research to heart will eventually need to come to terms with them by seeing the pretend money and the self-esteem associated with it disappear in a price crash. Ultimately, the easier path is grasping the concept of irrational exuberance early in one’s investing lifetime.
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