I suppose I ought to be more careful when I write, because, although I started writing this blog for the purpose of rehabilitating my stroke-ridden mind (and for no other purpose, really), people actually read things on the web.
Yesterday, I posted an article on Alan Reynolds‘s column in IBD, and (to my great surprise) Alan Reynolds himself actually replied! I am truly honored. It also shocked me into recognition of the fact that I am writing in a public space. So I thought I’d make a public response to Mr. Reynolds for two reasons:
- First, I want to assure Mr. Reynolds that I agree with his point about the Shiller graph and his conclusions about the weakness of Shiller’s conclusions, and that I was not attacking either him or the Wall Street Journal.
- Second, it will help me clarify the point I have been making (and will continue to make) about the differences between the philosophical point of view of progressive idealists, who base their thought about the future in observations about the past, and more the more cautious philosophical point of view of thinker like me, who wonders about the future based on their uncertain knowledge of the future.
Mr. Reynolds starts out by saying this:
Authors don’t usually get to pick their titles, and I made no mention of the “permabear press.”
I get that. I even talked about headline writers, their job, and how sometimes they exaggerate to get readers to pay attention in my book, Writing for People Who Hate Writing. I actually liked the title. Sorry for any misunderstanding in my use of it.
My point about saying that you didn’t make any mention of this was supposed to be countered by the next sentence in which I said something like:
That’s fine. His article is published on the editorial page of IBD. It’s up to the individual to make up his or her own mind, and this is done by gathering as many different points of view on the subject at hand and weighing your own opinion for yourself.
It was intended to make clear that I was making a different (not a larger or better) point. I’m afraid I wasn’t as clear as I might have been there. Sorry.
You go on to say:
I did suggest that the Wall Street Journal had used the same argument about P/E ratios a year ago as it did recently, and that Bob Shiller is a common source. To critique the Journal was hardly partisan, unless that means being unfair to Republicans.
I did not want to get into an argument with the Journal, or with you. I fear I was not clear in my position on your article. So, to be as clear as I can be: I wholeheartedly agree with you on Shiller, your take on looking forward, and the requirements that we need to look at interest rated more closly than Shiller does. Totally. 100%.
My Point
My point was a more abstract one. I was attempting to contrast my philosophical view of the past, present, and future with the idealist and progressive philosophical view of past, present, and future. I was talking about P-E ratios specifically so that I could enumerate the attitudes one could take towards them if you found out that they existed and you didn’t know what they were. This is a position that many of my readers (and there are not that many) are in. Indeed, this was the lamentable position I found myself in after getting my PhD in English Literature and finding myself in a job where I had little business experience. My solution was to read up on all things business.
But that is not the only thing one can do in the circumstance where you suddenly run across P-E ratios. One could also ignore the notion of a P-E ratio and decide they liked or hated your (Alan Reynolds) article based on your past track record. What I suggested was that it was a bad idea was to take the position that you didn’t need to know what a P-E ratio was and to continue on as though what you don’t know doesn’t exist (as Benjamin Jowett is supposed to have done).
Obama’s Health Care Plans
What I was saying was that I didn’t think it was right for people like Obama to come out with a health care plan without even understanding the difference between backwards-looking assessment of the stock market and forward-looking assessment. If they decided that they knew the results of their assessment of the stock market and decided they were okay with it, that would be one thing. If they don’t even know what they don’t know (as I think my article suggested about the Obama administration), that would be an altogether different set of circumstances. They would be walking us into the twilight of America with all the bright optimism and confidence of Hitler sending his generals into Stalingrad. His (Hitler’s) optimism was surely comforting for his generals to have, but the science of the situation cannot be ignored.
Your Point About Shiller’s Model
You had made the case that Schiller was looking backwards:
Shiller doesn’t just attribute p/e ratios to earnings, since earnings are the denominator of the ratio. What he does is relate current stock prices to average earnings over the previous ten years, like driving while watching the rear view mirror.
I agree with you, and this is the reason why I decided to publish my article on your column. It clearly delineates those who look towards the past to determine the future from those who use more subtle and varied measures of looking at the future.
My Lecture To My 12-Year Old Son
My example of this would be when I had my 12-year-old son look at a 1-day stock chart and asked him where he thought the stock market would go tomorrow. It had been going down all day, and he said he would go down. Then I had him look at a 1-week (5-day) stock chart, and it showed the stock market going up. When I asked him to look at the chart and to guess where the stock market would be going in the following week, he said up. I repeated this using various charts—a month, 3-months, a year, 5 years, until we got all the way back to the whole chart from the beginning right up to the present day.
From there my son could see what my father told me about the stock market: if you hold stocks long enough they tend to go up. This, I think, was what you were saying about Shiller’s chart “driving while looking in the rear view mirror.”
But when I asked his what stocks he should pick out of all the stock available to him. And I reminded him that some stocks have gone all the way to zero in the history of the stock market. I also gave him a lesson in the difference between growth stocks like Wal-Mart and Microsoft in their heyday and the same stocks in more recent days where they have been traveling in a narrow range of values. Had my son decided to invest in Microsoft in its heyday, he could have made a lot of money. Had he decided to invest in Microsoft as it traveled between two well-defined ranges he could have still made money, but only if he decided to trade on a different time-frame.: selling short at the top, and buying at the bottom of the range. The long-term strategy would have done him no good, sine in the long-term the stock remained stagnant.
He eventually decided that the safe thing to do would be to invest in an ETF fund pegged to the Dow fund like DIA. But I pointed out how much such cautious trading would cost if he were to pursue that strategy with real money. Most of the profit would be lost in a safe Dow strategy, and those who knew more about the subtleties of stock trading would be able to leapfrog over him. They would get rich, while he would remain (comparatively poor). Those who take risks reap the greatest rewards. All the subtly of the various positions would be lost if there was only one officially-sanctioned trading position which all had to follow.
Past Performance Is No Guarantee of Future Earnings
And, as you say, there’s more. Past performance is no guarantee of future performance. And we need to peg our reading to more than past stock performance:
What I showed is that the inverted p/e ratio (the e/p ratio) tracks interest rates, so we cannot say whether today’s p/e ratio is high or low without relating that to interest rates.
I think there’s more to think about that even your note to me portends (and this is absolutley not a critique of you, who know more than I do about this, and, I am sure, about everything else). Today’s IBD is telling me that stock prices are in a “confirmed uptrend,” and so I am willing to make short-term investments. But I have much more serious reservations about the long-term future of the stock market.
A couple things stick out:
- The country’s mounting problem with debt, that the Obama administration seems completely indifferent to in their pursuit of healthcare.
- The fact that stock prices are indeed rising, but they are rising against a falling dollar.
- The FOREX sites are telling me to invest in commodities against coming inflation,
My Point About the Obama Administration
My point was that the Obama administration seems to have no clue about forward-worriers like me, since they have no one in their cabinet who has ever had to worry about the future. Obama has filled his cabinet with people who are from academia, which is filled with academic progressive idealists. Obama himself dismisses forward-worriers like me, who tend to be cautious with my money (because it’s my money), as people who are only engaged in ‘talking points,’ and who have no reason behind their logic other than a vague, abstract fear, which Obama himself seems to think could be cleared up if only I could take the long view of the past, as he and Shiller have.
My fear is that Obama shares the delusion of the academic idealist. The academic idealist is happy looking at the past from the dignified position of those who deign not to worry about petty things like money, which he and his kind have long since gotten past worrying about. From the perspective of Shiller and Obama, as for the academics in my experience as a PhD student, such things as objections which arise from the “messy” Washington processes are no more than useless positions taken by those who cannot take the long view of the past that they themselves have come to. There is no more than one perspective in their worldview, and those (like me) who do not share it can be ignored in the interest of the greater good, which people like me are too blind to see.
My article is one of a series in which I am planning on differentiating my philosophical position from the idealist position. I hope that helps you to see my position more clearly, and thanks again for visiting my web site.