It takes a big psychological shift to recognize that some stock price gains are negative

Robert Shiller’s Nobel Prize-winning research showing that valuations influence long-term returns fundamentally changed our understanding of how stock investing works. It took a long time for most of us to understand the broader implications of this remarkable study.

Not all stock gains are positive.

Shiller’s research shows this. But how many of us today believe that? Not much.

If valuation affects long-term returns, the official stock price is not necessarily the actual price. If there is irrational excess in stock prices, it is partially disguised. The virtual part of the stock price will disappear over time. This is why valuation levels affect long-term returns. Prices always move in the direction of real value over time. so. If a stock is overpriced, you can expect its long-term returns to be lower than typical long-term returns.

This means that the best stock price for investors is its fair value price, i.e. the price associated with its CAPE value of 17. Any price increase that raises CAPE above 17 is a temporary gain. Investors cannot rely on them for financial planning purposes. It would be better if such false gains did not exist. Investors will have to shell out more cash to purchase stocks as long as the false profits remain, but it is not financially beneficial as they always disappear over time.

It would be better if such false gains did not exist!

That’s an amazing statement.

Some stock price increases are negative

For as long as stock markets have existed, investors have been rooting for prices to rise. But we now live in an era where there is peer-reviewed research showing that some price increases are actually negative. I’ve been trying for years to understand why more investors don’t incorporate Shiller’s findings into their stock investment strategies. I’ve come to believe that one of the big reasons for this is that it leads to a very counterintuitive understanding of how stock investing works for people who were accustomed to it in the pre-Shiller era. Some stock gains are negative! really?

really.

Some stock gains are negative.

When trying to come to terms with such a counterintuitive conclusion, I think it’s helpful to focus on the title Schiller chose for his book. The title of the book was decided. Irrational passion. That doesn’t sound good, does it? Shiller showed that investors sometimes do not make choices that advance their own interests. They intentionally reduce the value of your portfolio. Thinking about it makes your brain hurt.

When we recognize that we are doing things to make ourselves poorer than we need to be, doesn’t it make sense that the gains we produce then have negative rather than positive consequences? In a rational world, stock profits would always be positive. However, the world we live in is not a completely rational world. As long as humans purchase stocks, there will be irrational purchasing decisions. And as long as there are irrational purchasing decisions, there will be price increases that will have more negative than positive consequences.

Of course, price increases that reflect economic reality are always positive. The problem with irrational enrichment interests is that they are not rooted in economic reality. They are a product of investor sentiment and nothing more. So they lack staying power. The secret to effective long-term stock investing is learning how to distinguish economically-based profits from fake, irrationally exaggerated profits.

It is not a difficult intellectual task. The real profit would be to push the stock price up to its fair value CAPE value of 17. As it is now, with a CAPE value of 34, only half of the officially stated portfolio value is the real value. Shiller’s research shows that a portfolio said to be worth $100,000 has a real, lasting value of only $50,000.

Emotionally accepting that reality is the difficult part. Most investors don’t want to hear this. And most investment professionals don’t want to say it, because most investors don’t want to hear it. So we continue to live in a world of delusion. Some stock gains are positive and some are not.

Some stock gains are negative! Believe it or not, that’s what the research says.

Rob’s bio is here.