Lessons from the Nobel prize winning economists

Investors can learn from the differences of opinion between Eugene Fama and Robert Shiller, the winners of this year's Nobel Prize in economics.

The news that Eugene Fama and Robert Shiller were to share this year's Nobel Prize in economics left many wondering if the Royal Swedish Academy of Sciences "had a sick sense of humour", says John Authers in the FT.

The two are famously on opposite sides of a key question. Shiller's work has centred on irrational ups and downs in asset prices. But as far as Fama is concerned, markets are efficient, and thus priced correctly, so there can be no such thing as a bubble.

Yet investors can benefit from them both, says The Economist. It's a question of time frames. Fama's main insight is that stock prices factor in all available information immediately, so prices are extremely hard to predict in the short term days or weeks.

So, professional fund mangers are unlikely to beat the market, making paying up for active' funds an expensive waste of time. Investors are better off with a tracker fund, whose fees will be lower.

Shiller's work, by contrast, shows that over periods of several years stock prices are predictable, as valuations tend to revert to the mean. He devised the cyclically-adjusted price/earnings ratio (Cape), which uses a rolling ten-year average of earnings, and saw that when stocks are highly valued by this measure they would eventually fall hence his warnings about irrational exuberance in the 1990s.

The 1990s also showed that Cape, while a good indicator that a market will fall, does not predict when the fall will come.

The upshot, says The Economist, is that investors should have more of their portfolios in low-cost trackers, and be wary of equity markets where Cape is above the long-term average.

Recommended

How long can the good times roll?
Economy

How long can the good times roll?

Despite all the doom and gloom that has dominated our headlines for most of 2019, Britain and most of the rest of the developing world is currently en…
19 Dec 2019
James Anderson: investors must pay "high multiples" for tech stocks
Tech stocks

James Anderson: investors must pay "high multiples" for tech stocks

Investors must be willing to pay “unreasonable prices” for high-tech growth stocks to take advantage of the huge potential returns that these companie…
14 Sep 2020
Daniel Loeb: fiery activist goes on a buying spree
People

Daniel Loeb: fiery activist goes on a buying spree

Daniel Loeb is known as a sharp-tongued investor who buys stakes in companies and then shakes them up. But the pandemic caught him flat-footed and he …
14 Sep 2020
Anatole Kaletsky: I was wrong to be bearish on stocks
Investment gurus

Anatole Kaletsky: I was wrong to be bearish on stocks

There are “three clear reasons” for equity markets to keep climbing, says Anatole Kaletsky, chief economist at Gavekal.
1 Sep 2020

Most Popular

Will a second wave of Covid lead to another stockmarket crash?
Stockmarkets

Will a second wave of Covid lead to another stockmarket crash?

Can we expect to see another lockdown like in March, and what will that mean for your money? John Stepek explains.
18 Sep 2020
Here’s why you really should own at least some bitcoin
Bitcoin

Here’s why you really should own at least some bitcoin

While bitcoin is having a quiet year – at least in relative terms – its potential to become the default cash system for the internet is undiminished, …
16 Sep 2020
James Ferguson: How bad data is driving fear of a second wave of Covid-19
UK Economy

James Ferguson: How bad data is driving fear of a second wave of Covid-19

Merryn and John talk to MoneyWeek regular James Ferguson about the rise in infections in coronavirus and what the data is really telling us.
17 Sep 2020