Assurance That Stock Prices Will Go Back Up Again Don’t Count for Much After a Crash

I am worried about what will happen in the days following the next price crash. Today’s CAPE value is 36. The mean CAPE value is 16. So a drop to fair value price levels would mean a price drop of more than 50 percent. At the end of earlier bull/bear cycles, the CAPE fell to […]

Free Book Preview
Money-Smart Solopreneur

This book gives you the essential guide for easy-to-follow tips and strategies to create more financial success.

May
11, 2021

6 min read


This story originally appeared on ValueWalk

I am worried about what will happen in the days following the next price crash. Today’s CAPE value is 36. The mean CAPE value is 16. So a drop to fair value price levels would mean a price drop of more than 50 percent. At the end of earlier bull/bear cycles, the CAPE fell to 8. A drop to 8 would translate into a price drop of more than 75 percent. Many trillions of dollars of spending power would disappear from the economy. Hundreds of thousands of businesses would go under. Millions of workers would lose their jobs. Political frictions would be exacerbated.

Q1 2021 hedge fund letters, conferences and more

We are going to need to reassure investors at that time. I don’t think that we should try to persuade them to buy enough stocks to push the CAPE back to today’s level. We are all better off when stocks are priced at fair-value levels. So a CAPE of something in the neighborhood of 16 would be good. An argument could be made that something a bit higher than that might be better. We have to make the trip down to fair-value prices at some point. But that is such a long trip that it might be better to achieve it in stages. A drop to something a bit closer to 16, followed by some time for stock investors to catch their breath before a further drop to 16, might be ideal.

It certainly would not be good for the CAPE to drop to levels near 8. That much of a contraction in the economy could bring on a Second Great Depression. But the reality is that investors will be frightened when the longest and strongest bull market in U.S. history finally comes to an end. It is not going to be easy to keep an out-of-control greed from turning into an out-of-control fear. Policymakers and thought leaders in the investment advice field will need to think carefully about what words to offer to reassure investors that they should not abandon stocks at that time.

I am concerned that the efforts made to do so will be one-dimensional. Investors will want to hear that stock prices will quickly head back upwards and many will feel a temptation to tell them what they want to hear. Say that investors are told that things will be back to normal within six months and then that doesn’t happen. Investor mistrust will deepen. Promises that do not come true will make a bad situation worse.

The good news is that stocks offer an amazing value proposition when priced at fair-value levels or better. So we won’t have to stretch the truth to argue that stocks are worth buying. But there are different ways to convey that message. The approach chosen is likely to determine the long-term success of the message.

A message that “stocks are always worth buying and so of course they are worth buying now” will not get the job done, in my assessment. That’s the Buy-and-Hold message. It makes the sale today because investors look at the numbers on their portfolio statement and like what they see. The message does not stand up to logical scrutiny. Nothing is worth buying at any possible price. The emotional appeal of the message will be lost after prices have fallen and investors have paid a price for placing their confidence in a message that in ordinary circumstances all would view as nothing more than a sales pitch. We are going to need to do better in the days following a devastating price crash.

Buying Stocks Following The Next Price Crash

We are going to need to come clean with investors. We are going to need to tell them that, no, stocks are not always worth buying, but that, yes, they are worth buying at the prices that apply following a massive price crash. That message is believable because it contains an acknowledgment of the cause of the wealth destruction from which investors will be seeking to recover. The number-one question on the minds of investors in that day will not be — Where should I invest the money still remaining in my possession? The number-one question will be — What happened to my retirement account? We need to answer that one honestly to begin to reestablish trust.

People don’t buy stocks (or anything else, really) solely because of logical presentations of the pros and cons. Any salesperson will tell you that people make purchase decisions primarily because of their emotional impressions of the product and of the salesperson making the case for it. People are going to be angry at everything having anything to do with stocks at that time. The first step to persuading people to buy again will be convincing them that something has changed, that the investment advice field has become more trustworthy.

Investors are going to want to hear an apology. That’s the short version of what I am saying here.

Economic Developments Cause Stock Price Changes

I remember a poster at a discussion board who asked after reading an article saying that $5 trillion worth of wealth had disappeared in a few weeks: “Where did all the money go?” Where did all the money go? That is the question that will be on investors minds in the days following a massive price crash. The Buy-and-Holders do not have an answer to that one. The Buy-and-Holders claim that stock price changes are caused by economic developments. People are not going to believe that trillions of dollars of wealth were lost in a matter of week because of economic developments. They are going to need to hear something more reflective of the magnitude of the catastrophe.

Robert Shiller’s research provides that. If irrational exuberance is a real thing, price gains beyond those that would apply if stocks were priced at fair-value levels (a CAPE of 16) are temporary and illusory. Losses of the kind that we are talking about here should be expected in a world in which Buy-and-Hold is promoted relentlessly but in which irrational exuberance is a big part of the story.

I think we need to come clean following the next price crash. Irrational depression is even more damaging than irrational exuberance. When huge amounts of wealth have been destroyed, people are afraid and untrusting. Fearful and untrusting people do not put what assets they have remaining at risk in response to further iterations of the same old story. Investors of that day are going to need to hear a story that rings true in light of recent developments, not the same story that caused the problem that people are trying to recover from.

Rob’s bio is here.

No Comments Yet

Leave a Reply

Your email address will not be published.

 

The Abundance Pub (TAP) is a media source dedicated to all things positive in the world. Focusing on Health, Wealth and Happiness. The Abundance Pub serves as repository of positive news articles, blogs, Podcasts, Masterclasses and tips to help people live their best life!

FOLLOW US ON

Message From Founder