Irrational exuberance
| Robert Shiller Irrational Exuberance New Jersey: Princeton UP, 2000. |
An economist who works on market volatility, Shiller offers an interpretation of the US stock market highs, arguing that Alan Greenspan’s term “irrational exuberance” is a good description of the mood behind the market. His PE ratio charts are a quite, quite scary look at the noise and confusion of the market, showing that the market is overvalued by historical standards.
The message: the stock market is often not well anchored by fundamentals. People think they know more than they do. They like to express opinions on matters they know little about, and they often act on these opinions. They do not know to any degree of accuracy what the right level of the market is, whether it is over- or under-priced. A sucker on the market is born every second. People are prone to herdlike behaviour arising from information cascades, with the failure of information about true fundamental value to be disseminated and evaluated.
Shiller credits an unprecedented confluence of events with driving stocks to uncharted heights, and analyses the structural and psychological factors that explain why the Dow Jones Industrial Average tripled between 1994 and 1999. Precipitating factors he studies include analysts’ increasingly optimistic forecasts, the expansion of defined contribution pension plans, the growth of mutual funds, the decline of illusion and the effects of the money illusion. Low inflation boosts public confidence, hence stock market valuation, but Shiller points out that this reaction is inappropriate. Nominal interest rates are high as they must compensate investors for the inflation that is eroding the value of our dollars, but the market tends to be depressed when nominal and not real rates are high.
There is a sound study of the amplification mechanismsin the market, a kind of feedback loop. Investors, with confidence and expectations buoyed by past price increases, bid up stock prices higher, thereby enticing more investors to do the same, and so the cycle repeats itself over and over again in a speculative bubble. (Shiller uses an example of Albania in 1996 and 1997 when Ponzi schemes accumulated some $2 billion, or 30 per cent of the GDP. When the schemes failed, protesters looted banks and burned buildings, and the chaos forced the resignation of PM Aleksander Meksi and his Cabinet.)
This is a good call for a sensible account of emerging risk-management principles.
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 hwo are motivated substantially by their own emotions, random attentions, and perceptions of conventional wisdom. Their all-too-human behaviour is heavily influenced by news media that are interested in attracting viewers or readers, with limited incentive to discipline their readers with the type of quantitative analysis that might give them a correct impression of the aggregate stock market level. (203)
I’m interested in a Singapore equivalent of how interest in the stock market has been drummed up. You can see how the unit trust market is taking off in Singapore, with the emerging popular concept that unit trust investing is sound, convenient and safe tempting naive investors to participate in the market, leading them to think that the experts managing the funds will steer them away from pitfalls. The papers jazz up the money section and play it up in the Sunday editions, the banks and insurance agents keep pushing investment-linked products and funds at us. We are building casinos:
The rise of gambling institutions, and the increased frequency of actual gambling, have potentially important effects on our culture and on changed attitudes toward risk taking in other areas, such as investing in the stock market. (41)
On the macro level, Shiller says that the valuation of the stock market is an important national, indeed international, issue. Our plans for the future hinge on perceived wealth, and plans can be thrown into disarray if much of that wealth evaporates, I’m sure we can think of examples where economic disarray provide fertile ground for extremist thinking.
(This book was written in 2000. Between March 2000 and October 2002, US stocks lost 50.2 per cent of their value, or $7.4 trillion. In 2002, investors yanked $27 billion out of stock mutual funds. The same people who were eager to buy stocks in the late 1990s, when they were going up in price and becoming expensive, sold stocks as they went down in price and, by definition, became cheaper. Same old story as in 1929, and in the various booms and crashes after that. )