Irrational Exuberance, One Year Later

Of all the books and articles written about the U.S. stock market in recent years, few, if any, were as well-timed as Yale professor Robert Shiller's Irrational Exuberance. Published in mid-March of last year, just as the Nasdaq and S&P 500 began their long slides into bear territory, Shiller's book argued that the markets were in a "speculative bubble" largely spurred by "investors' enthusiasm rather than by consistent estimation of real value."

Irrational Exuberance -- Shiller used the phrase during testimony before the Federal Reserve, and Alan Greenspan repeated it in his famous December 1996 speech -- is now being issued in paperback, with a new afterword. The year-long market decline has left Shiller slightly  less bearish on stocks and more supportive of individual investors than he seems in the book, though it's all relative: Last year, BusinessWeek called Shiller "not merely a bear," but "a grizzly."

Either way, Shiller's book was not focused on when the bubble would burst, but instead on its longer-term consequences. Irrational Exuberance notes that speculative bubbles in the past have been followed by up to two decades of below-average market returns, so we may not be out of the woods yet. In an April 6 interview, Shiller did not come down too squarely on one side or the other of that question, but it's clear he still considers the market highly valued. He also responds to his many critics. 

TMF:  Let's start out with an easy question. Given that you wrote a book arguing that the market was overvalued right before a major correction, would you like to say, "I told you so"?

Robert Shiller: [Laughs] Well, I don't know, I didn't have any clear sense of the timing. I had a feeling that the market was going through a very unusual circumstance, but I didn't know it wasn't going to go up for the next year, so I count it as luck. Incidentally, I was mainly talking about the long run. In another year, the market could be back up again, though I'm thinking that's less likely now, but... there's a lot of uncertainty.

I don't think people should judge forecasters on one event. I don't think anything the market does is a verdict on what I wrote about in the book.

TMF: You probably get this a lot, but an obvious next question is, what happens now?

Shiller: One thing that comes to mind is that, as I said in the book, I think that the irrational exuberance that we saw at the turn of the century -- in 2000, I mean -- was really extraordinary by historical perspective, and so it would be reasonable to think that it won't happen right again.... I think the market might go up, but I think it's unlikely that it's going to go surpassing the old peaks for a long time.

TMF: Right. Well, you talked about this in Irrational Exuberance, that -- to quote from your book -- "the outlook for the stock market into the next 10 or 20 years is likely to be rather poor -- and perhaps dangerous." Do you still feel that way about the long term?

Shiller: It's not as dramatic now, because I was measuring from where we were then. It's certainly much less dramatic for the Nasdaq, and it's starting to get a little puzzling. But the markets overall still seem to be very high, by price-to-earnings ratios.

It was just called to my attention that if you look at the median price-to-earnings ratio on the Nasdaq -- it's the Leuthold Group that has been doing this -- it's back down to its average since 1971. But if you look at the P/E on the Nasdaq as it's actually calculated [total share price over total earnings per share], it's over 100. So this is where it starts to get more ambiguous. I'm inclined to think that if you want to look at the Nasdaq as a whole, you should look, not at the median, but the total price over the total earnings, and it still looks very high.

TMF: Some of your critics note that you've been bearish for several years, going back at least to late 1996. How do you respond to critics such as James Glassman and Kevin Hassett, authors of Dow 36,000, who wrote a Wall Street Journal item recently comparing market "pessimists" to "stopped clocks" who "will occasionally seem right"?

Shiller: Well, at least I seem right! [Laughs] They've never seemed right. Since they came out with their book, it's been a disaster....

Incidentally, I was giving in '96 a long-run forecast, so it's not at all clear that I was wrong. In fact, we're getting back down [to that level]. If you take -- they'll point out the Dow was 6700 in '96 -- if you correct that just for inflation, that's 7500, and you know we're not that far [from that]. I don't think I was wrong, I think I was right. And in fact, the issue is, the market looked overpriced there [in '96], and it looks even more overpriced now, and so I think I was right to raise concerns, and to continue to raise concerns, because it's such an important issue that's affecting people's lives in such a major way....

If you're bearish, you'll probably be bearish until the market comes down... it's not an error to stay with one view.

TMF: Throughout the bull market, there were a lot of comments, particularly from bears, about widespread stock investing among the broader public as potentially a sign of a bubble. For example, you hear the story about shoeshine boys on Wall Street trading stock tips before the Great Depression. Do you think there is a direct relationship between popular interest in the market and speculative bubbles?

Shiller: One thing is I think that popular interest in the market is going to stay with us. It's partly due to institutional things: 401(k) plans have forced people to make a choice, whereas before they wouldn't have even had this choice presented to them. And so, people have learned about stocks. And I think that we will continue -- this isn't itself evidence of a bubble, just that more people are getting involved -- it's actually just a good thing.

But it seems like a bubble happened at the same time, and it's maybe partly due to the inexperience of new people coming into the market that could be a factor. But I don't think it's the bubble itself. There are some people drawn into the market by the bubble. Those are people who keep hearing about it, everyone's talking about it, and they're getting excited, they hear about their friends making a lot of money, and so they want to do it too. And that kind of thing can get reversed.

TMF: So when you hear the estimates of 48% of U.S. households holding stocks either directly or through mutual funds, is that something that has to change for the market to turn around?

Shiller: No, I think that's a good thing, and it's going to keep going up. The market will very likely come down, and we'll see 55% [of households] in the market. I think it's a good thing.

Part 2 »