It seems like eons since
uttered his famous warning about "irrational exuberance" in 1996, but economist
, a professor at
, thinks the idea still holds sway in the markets.
Recent Daily Interviews
Fremont Investment Advisors'
Leeb Capital Management's
T. Rowe Price's
Mercer Management Consulting's
Federal Reserve Bank of New York's
book on the subject appeared around the time of the market peak last spring (see
review), Shiller would argue that not much has changed. While valuations have gotten knocked down a lot, he believes they might still have a lot further to drop.
In fact, Shiller doesn't expect irrational exuberance to die out for a least another year or two -- an opinion given some legitimacy by the recent upticks in the markets, despite a continuing barrage of bearish earnings reports. As of Friday's close, the
Nasdaq was up 29% from its April 4 low, the
S&P 500 was up 13% from its low on the same date, and the
Dow was up 15% from its low on March 22. Below, Shiller explains why exuberance still prevails -- and why a stock-centric investment focus may eventually become a relic of the past, making way for whole new markets in entities like national income and single-family home prices.
TSC: Where do you think the market stands now, valuationwise?
: I'm still not optimistic about the market. The
P/E as I computed it on the S&P got as high as 46 last spring and is now
during intraday trading Monday 34. It has come down quite a bit but is still very high. The historical average is around 14. So it seems to me like the idea that P/E ratios don't really matter is still with us. We've adjusted up our sense of what's reasonable for a P/E, and that adjustment hasn't corrected.
TSC: How do you explain the run-up we've seen recently?
: There have been
market rebounds before -- since the peak in March of 2000. In January of this year there was a 14% increase in one day on the Nasdaq when the
Fed cut interest rates. Then when they did the intermeeting cut, the Nasdaq went up 8% in one day. It seems like there's a lot of faith and hope in Alan Greenspan. Some people talk about the "Greenspan put" -- he won't let the market go down. And when he takes action, there seems to be a period of reassurance. There are people looking at history, expecting some kinds of simple patterns to repeat -- whenever the Fed makes cuts like this, the market is always up three or six or 12 months afterward.
I'm skeptical that it will do that now, though it could, because we're in a rather unusual situation -- the market is still very high, the economy is kind of tipping. It may be going into a recession; it may not be. I tend to think the simple fact of overpricing is not properly accounted for --
simple gravity is going to pull the market down.
TSC: So far, how does this downturn compare in severity to other big drops we've seen, like in the '30s or '70s?
: In terms of the Nasdaq, it got down about 60%. Now that's very big, but of course the Nasdaq is not the whole market. If you look at the S&P 500, which is a bigger share of the market, it was down something like 30%.
Going back to the 1920s, the monthly S&P index peaked in September of 1929 at 31.3. The bottom was in June of '32, when it hit 4.77. So it lost 85% of its value from 1929 to 1932.
I think the current market could go down a lot further as the P/E goes back to the historical average. If the market's P/E fell to 13.2, that would mean falling another 40% or so. And of course P/Es can go below average. Half the time they are below average.
TSC: So how long do you think a downward adjustment like that would take?
: Typically, over years, the market would be bumping up and down. You just have more down days than up days. It's quite plausible the S&P 500 will be below 1,000 in a year or two, and people will be wondering, how did it get there?
TSC: In terms of investor sentiment, what do you think we're seeing now, compared with the irrational exuberance we saw before? Watchful exuberance? Is there still exuberance in the market?
: I think it's fading, but still in the area. So many people are thinking still that it better come back -- there's still a lot of faith the Internet is going to push the market up. If it's a question of where you draw the line -- when did irrational exuberance end -- I'd probably draw the line sometime in 2002 or 2003.
TSC: Assuming the market does keep dropping over time, do you think individual investors will become less interested in the market? That it will become less important in a cultural sense, as a topic for water-cooler talk?
: It probably will take years for people to lose interest, but I think that's likely to happen. It was just so much fun when the market was going up. In the '20s, people everywhere were talking about the stock market, but I think that's more true now than then. I counted articles in the
about the stock market and computed the fraction for all articles about the market. We were higher at our 2000 peak than we were in the 1920's peak.
But when the market's going down, I think maybe we'll watch the football game instead.
That's the way history changes. When you're calling me up 10 years from now, it won't be about the stock market. Part of my theme is that financial markets will develop in such a way that the stock market isn't so emphasized. It's not as big a part of the economy as people think.
TSC: What would take its place?
: I think we should have big markets in real estate, in single-family home prices. Or markets for national income. It's already starting to happen. I'm told we now have them in several countries, that Bulgaria has GDP warrants now. So we're beginning to see other markets develop, so that in the long run, the Dow, the
NYSE and the Nasdaq
will become less important. There will be other kinds of speculation markets.
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