, by Robert J. Shiller. Princeton University Press, April 2000; 233 pages.
On Wall Street, timing is everything. And considering the stock market's frightening fall on April 14, and subsequent turbulence,
Robert J. Shiller
couldn't have better timed the release of his book,
. Shiller passionately believes that
Federal Reserve Board
was right when he used the term "irrational exuberance" to describe investor behavior in a famous late-1996 speech. The steep climb in the stock market that followed meant a speculative bubble of historic proportions had developed, according to Shiller.
In finance, "bubble" is an especially ominous -- yet fascinating -- term. A bubble is a speculative buying binge that sends the stock market -- or any other asset, for that matter -- to heights far beyond the realm of reason. The cycle of prosperity leading to a mass investment delusion, and ending in catastrophe when the bubble bursts, has a long history: The tulip-bulb mania in 17th-century Holland; equities in 1920s; the fifty high-priced glamour stocks of the 1970s -- the so-called Nifty Fifty; the Japanese stock market in the 1980s.
Similarly, people are currently optimistic about the stock market's upward prospects, says Shiller, an economist at
. "There is a lack of sobriety about its downside and the consequences that would ensue as a result. If the
were to drop to 6000, the loss would represent something like the equivalent value of the entire housing stock of the U.S. There would be harmful and uneven effects on individuals, pension funds, college endowments and charitable organizations."
is a manifesto for all investment professionals who grimace at phrases such as the "New Economy" or "this time is different." Shiller is no fan of the democratization of finance. He has written a well-researched polemic against the public's widespread embrace of stock ownership and the popular belief that stocks are the best long-term investment. He uses economics, psychology, sociology, demography and history to make his case that the stock market is dangerously overvalued. This book deserves a prominent place on any investor's bookshelf.
The Market Unmoored
No one doubts that the stock market is highly overvalued by historic metrics. Shiller runs through the standard benchmarks, such as corporate profits and
price-to-earnings ratios. He also touches on many popular justifications for the stock market's nosebleed levels, such as the advent of the Internet, the aging of the baby boom generation and a Republican Congress. He finds that all of these explanations, singly or combined, fall short. The stock market isn't anchored in economic fundamentals.
Little wonder Shiller takes on the dominant academic paradigm of an efficient market, populated with rational investors, coming up with a reasonable approximation of value at all times. He points out the flaws in the intellectual efficient-market edifice and reviews some well-known examples, such as the tulip-bulb mania and the Nifty Fifty, of sustained inefficient pricing in the market. Bubbles are both theoretically respectable and historically accurate.
The crux of Shiller's bubble argument is cultural. Equities are now part of our mass culture, a topic of discussion at work and at the neighborhood barbecue. Thanks to the media, such as
, people have largely absorbed a simplistic and optimistic story about investing, he says. The bubble is the result of a complex feedback between a cheering press and naive individuals. In sum:
The high recent valuations in the stock market have come about for no good reasons. The market level does not, as so many imagine, represent the consensus judgment of experts who have carefully weighed the long-term evidence. The market is high because of the combined effect of indifferent thinking by millions of people, very few of whom feel the need to perform careful research on the long-term investment value of the aggregate stock market and who are motivated substantially by their own emotions, random attentions and perceptions of conventional wisdom.
Where's the Bubble?
How persuasive is Shiller's case?
is a cautionary tale against extrapolating the stock market's stellar 18-year performance far into the future. History is littered with too many long periods of stock market stagnation or worse. Diversification pays.
Yet Shiller is less convincing when it comes to proving a bubble. For one thing, as he himself notes, the media is far from monolithic. It's hard to find a major news outlet that hasn't infused its market and economic coverage with warnings. For example, every December from 1994 to 1998, the consensus forecast reported in the major presses was that the economy would grow at an annual 1.7% to 1.9% pace and that inflation would pick up. Yet, the economy expanded at a 4% yearly rate during those years and the core rate of inflation dropped lower. Indeed, unlike other post-World War II business-cycle expansions, the economy is picking up as the expansion ages. Hindsight tells us that it wasn't just cultural fads and fashion that accounted for the remarkable gains in the market.
Even more important, Shiller doesn't grapple enough with the argument that the stock market reflects a striking improvement in productivity, largely driven by rapid technological change and organizational innovations. Productivity growth, the fundamental building block of higher standards of living, is running at about a 2%-plus pace -- double the rate of the business cycle upturns in the 1970s and 1980s. Productivity ran at a 3% annual rate in 1999, comparable to the stellar performance of the 1960s. Shiller also dismisses the economic impact of the Internet. Yet companies as diverse as
seem convinced that they can wring out new efficiencies by reorganizing their operations around the Internet. Management may be wrong, but the corporate bet is far from irrational.
is a sobering read. Yet, after putting the book down, I still feel that the stock market is better anchored in the economic fundamentals than Shiller believes. The gains in productivity achieved over the past decade are the result of deep structural shifts in the economy. The signs of change, significant change, are all around us. What's going on is reminiscent of railroad building in the late 1800s and the automobile investment of the early 20th century. Railroads went bankrupt and auto companies merged, but in the meantime, a new economy was built. Today, globalization, technological innovation and the democratization of finance are transforming the way Americans work and live. Along the way, fortunes will be made and lost. Stock prices will get out of whack with fundamentals. Companies will fail and products will vanish. But what's going on is real; we can feel the effects every day.
Chris Farrell is host and managing editor of Right on the Money, a nationally syndicated public television personal finance show; co-host of Sound Money, a public radio nationally syndicated personal finance program; and contributing economics editor at Business Week. He lives in Minnesota.
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