A Chat with Robert J. Shiller
Blind Faith?
Economist Warns of Speculative Bubble in Stock Market
May 1, 2000
If Federal Reserve Chairman Alan Greenspan told investors they were
irrationally exuberant, a new book by Yale economist Robert J. Shiller goes one step
further. In Irrational Exuberance, Shiller calls the present market a
“speculative bubble” that is likely to pop. Investors’ confidence in the
strength and future growth of the stock market is irrationally high, he argues, while
using economics, history, sociology, and psychology to explain how bubbles come about and
how they sustain themselves. Shiller joined us for an online chat today.
Moderator at 2:59pm ET
Welcome to the ABCNews.com chat with author Robert J. Shiller. Let's begin.
Moderator at 3:00pm ET
Where did the term "irrational exuberance" come from?
Robert J. Shiller at 3:01pm ET
The term first appeared in a speech that Alan Greenspan gave on Dec. 5, 1996. It was part
of a question, "How do we know if the stock market is in a state of irrational
exuberance." I don't think he's used it since, but it became his most famous quote.
I'm suspecting it will appear in Bartlet's Quotations some day.
Robert J. Shiller at 3:02pm ET
It has become a well-known name for the situation we see in the stock market. Even though,
I should add, Alan Greenspan never came out and said that he believes that there is
irrational exuberance.
Robert J. Shiller at 3:03pm ET
To me, it's a good description of the psychological state of the market right now. There
are other phrases that people use like speculative mania or speculative orgy that are too
strong. Exuberance gets the mood about right.
Howard from as.wcom.net at 3:03pm ET
If this is a stock market bubble, once it pops, how low and how long could the correction
be?
Robert J. Shiller at 3:05pm ET
I think the bubble metaphor, which has been attached to market situations like the one
we're in, is somewhat unfortunate, because real world bubbles, like soap bubbles, grow and
then pop suddenly and irrevocably. Stock market bubbles, you never know when they're
popped. You go through a period when there are more days down than days up for some time.
That's what happens.
Robert J. Shiller at 3:05pm ET
The question is, "How low can it go?" Recall that the stock market tripled in
the last five years, and we could undo a lot or most of that.
Moderator at 3:06pm ET
How long do you think the current volatility will last?
Robert J. Shiller at 3:07pm ET
There's always some uncertainty about forecasting, but I would think volatility might stay
up for years. Volatility stayed at very high levels from the years 1929 to 1933, and
factors encouraging volatility are somewhat persistent.
Moderator at 3:08pm ET
How does today?s market measure up to Japan's bubble market of the late 1980s?
Robert J. Shiller at 3:10pm ET
I have been doing questionnaire surveys of institutional investors in the U.S. and Japan
since 1989. I've tried to look for similarities in terms of attitudes with respect to the
market. The most important thing is that in both cases, Japan in 1989, and the U.S. now,
there were higher expectations for one's own market. In 1989 the Japanese were much more
optimistic about the Japanese markets than Americans were about the Japanese market at the
time. We're in a similar situation; Americans are very optimistic about their own market
now.
Robert J. Shiller at 3:11pm ET
There were very high price earnings ratios in Japan, as there are in the U.S. now.
Michael Dickman at 3:12pm ET
Do you see the bubble only in tech stocks or market-wide? (Cisco has a P/E of 187, Conseco
Financial has a P/E of 2.5)
Robert J. Shiller at 3:13pm ET
Tech stocks have shown many of the highest PE ratios. However, the market as a whole has
very high PE ratios too. This is partly because tech stocks are important in the market,
but also because there are other stocks with high PEs, such as Coca-Cola, Wal-Mart and
Disney.
Robert J. Shiller at 3:13pm ET
Of course, there are low PE stocks, too, and there always have been.
Moderator at 3:14pm ET
What are the key psychological factors that have made investors so positive about the
stock market?
Robert J. Shiller at 3:16pm ET
That is a very complicated question. There are very many factors that contribute to this
market. In my book, I list a dozen precipitating factors and then I give amplification
mechanisms that exaggerate the effect of these factors. And then there are psychological
principles of human behavior that are in the background all the time. The thing that
stands out most as a general principle is that there has been feedback from price
increases to more price increases, as is an essential element to speculative bubble.
SPM from scr.siemens.com at 3:16pm ET
What are your reasons for thinking that the current expansion is fundamentally unhealthy?
Mightn't we be seeing the economic expression of a technological revolution instead of
simply wild speculation?
Robert J. Shiller at 3:17pm ET
I think that the answer is both. We are undergoing both a technological revolution and
wild speculation. And these things do historically tend to occur together. It's very hard
to prove that the market reaction is an overreaction, but in historical perspective, it
appears that such overreactions are commonplace.
Matt at 3:18pm ET
At current P/E ratios, true stock yields without growth are minuscule. Why aren't people
migrating to investments, like bonds and real estate, with more attractive yields?
Robert J. Shiller at 3:19pm ET
Well, a common phrase when we talk to investors is that the stock market is "the only
game in town." There is a lot of attention given to the upside potential for stocks
and a feeling that there is little downside in the long run.
Bobe at 3:19pm ET
There are lots of books like yours published in the past 20 years or so predicting the end
of the American economy. What is different about your book and your predictions from all
the others?
Robert J. Shiller at 3:21pm ET
I'm not predicting the end of the American economy. It's a question of price: when is the
price right? One reason why the markets tend to overreact is that it appears unpatriotic
to say that the market's gotten too high. We have a great teacher for the economy, but not
quite as great as the market seems to think.
Robert from census.gov
at 3:21pm ET
In the latest edition of "A Random Walk Down Wall Street", Burton Malkiel
predicts the U.S. stock market will grow about 7% a year for the next couple of decades.
What do you think is the likelihood of that, and what is your position about the
correctness of the random walk theory of stock market price changes?
Robert J. Shiller at 3:22pm ET
I think it's unlikely that the stock market will grow as much as Burton Malkiel predicts.
Malkiel is neglecting to consider the overpricing of the market. Once when asked to
predict the Dow in the year 2020, I said, and I still stand by it, that a reasonable
forecast is 10,000. That kind of level accords with historical experience after major
overpricings.
Robert J. Shiller at 3:23pm ET
Of course, there's a lot of uncertainty about such a forecast.
Shannon from 210.149.65.boston1.level3.net at 3:23pm
ET
What do you think are effective ways to discourage speculative "herds" and
encourage rational, long-term investing?
Robert J. Shiller at 3:24pm ET
First of all, I don't know that there's a lot we can do. But one thing is to encourage
globalization since foreigners are less likely to be caught up in the irrational
exuberance. I have advocated raising margin requirements. But, again, there's no panacea.
Robert J. Shiller at 3:24pm ET
Public opinion leaders' expression of concern are helpful when the market gets underpriced
or overpriced.
Moderator at 3:25pm ET
Given that U.S. markets are so volatile, do you think that investors should be looking to
invest in overseas markets?
Robert J. Shiller at 3:25pm ET
Of course, that's a form of diversification and it's a good idea. However, one should
recognize that there is some tendency for stock markets around the world to work together,
especially U.S. and European markets.
Moderator at 3:26pm ET
What are the odds of a global depression, and how would such a scenario come about?
Robert J. Shiller at 3:27pm ET
I think that a global depression is quite unlikely, but a substantial recession is still a
possibility. Of course, a pick-up in inflation could encourage tightening of credit by the
Fed. We don't really understand the dynamics of inflation, so this could happen. Moreover,
a major decline in the stock market could set off a decline in confidence and make a
recession hard for the Fed to stop.
Robert J. Shiller at 3:28pm ET
In 1987, the stock market crash had little effect on confidence. But in another major
market decline, public reaction could be different.
Jon from stanford.edu at 3:28pm ET
Given the possibility that the market is at present excessively valued, what is the most
prudent course of action for individuals to take with regards to managing their savings
and investments?
Robert J. Shiller at 3:29pm ET
Individuals who are holders of stock portfolios have to decrease their reliance on them,
because their long term value is ephemeral. Of course, they can sell much of their
holdings. They should also consider increasing their rate of saving out of income and
should make efforts to maintain their labor income in the long run. This over confidence
in the market is causing some people to neglect their other sources of income.
Moderator at 3:30pm ET
How has the development of the Internet changed the face of the stock market?
Robert J. Shiller at 3:31pm ET
The Internet is of course, an extremely important technological innovation, just as was
the invention of the railroad or of the automobile. It's an important innovation, but
probably not the most important innovation that we've seen in the last century. But it
does stand out in its visibility to investors. We use it every day and have hands-on
experience with it. This causes us to react much more to it in assessing the future.
Jesse at 3:32pm ET
How do you think the market will be affected by the breakup of Microsoft? If they stay
together?
Robert J. Shiller at 3:34pm ET
There was a big market drop in the week ending April 14, and the news media attached the
Microsoft story to this drop, because it was the only big story. That's the kind of
process whereby the significance of stories tends to be exaggerated in the public mind.
The long run significance of the Microsoft case is very hard to predict, but the fact that
there were market declines at the time has created the interpretation that the decision is
bad for the market.
Moderator at 3:34pm ET
You dedicate a section of the book to describing the hype that emanates from Wall Street,
especially from analysts and journalists. How does this hype effect stock prices?
Robert J. Shiller at 3:36pm ET
One thing that's happening is that there's so much attention in the media to analysts and
the stock market that it operates like a huge advertising campaign for stocks. Advertising
people know that to generate real, effective demand on the part of the public for a
product, you have to advertise. The stock market is getting a lot of ads these days. A lot
of the media tend to feature a lot of people whose job is selling stocks, because the
public likes to hear them, and they're very happy to appear on TV shows doing this.
Moderator at 3:37pm ET
What role do you think the government should play?
Robert J. Shiller at 3:39pm ET
I make an analogy in my book to markets and political elections. With elections, the
government's role is to make sure we play by the rules of the game, that we have good laws
regarding campaigns, preventing fraud and other abuses. For financial markets, we have
federal watchdogs at the Securities and Exchange Commission, who do things like this. The
Federal Reserve should not attempt to "prick the bubble" which would be medicine
worse than the disease if done zealously. But, they might lean against it a little.
Robert J. Shiller at 3:40pm ET
I have advocated that the Federal Reserve should at this time raise margin requirements.
The government should not embrace simple solutions to problems like the social security
crisis, that rely on assumptions that the stock market will do well.
Dave in Birmingham at 3:41pm ET
The stock market seems to have become all about speculation, it's just like a casino these
days. Are there no proposals for reforming trading to minimize this?
Robert J. Shiller at 3:42pm ET
There are such proposals. One proposal which was once aired by U.S. Treasury Secretary
Lawrence Summers is that we put a transaction tax on securities trades. He has backed down
from that, incidentally. Another proposal has been to raise capital gains taxes. That's
not in fashion these days, either. I have not advocated either of these things. Their
effect is uncertain and they inhibit the proper functioning of markets.
Bill Innanen from jhuapl.edu at 3:43pm ET
I've seen "analysis" that implies that much of the money fueling the stock
market's rise of the past few years is due to Baby Boomers belatedly stashing money in the
market for their retirement. If that is true (what's your opinion?) then could we expect
it to last until the BB's start retiring?
Robert J. Shiller at 3:45pm ET
I think there may be some truth to this theory. Moreover, belief in this theory is
widespread. It's one of the reasons why people think the market can't go down and is the
only game in town. However, demand by baby boomers is not necessarily going to propel the
market, in theory. There are too many other factors affecting it. The market does not have
to crash just because baby boomers are retiring in 20 years, because the rest of the world
is growing and might buy the stocks then.
Moderator at 3:46pm ET
Was the 1929 stock market crash a main cause of the depression in the 1930s, and would a
similar decline in equity values lead to a steep downturn in the real economy?
Robert J. Shiller at 3:48pm ET
A very important factor in the depression of the 30's was a loss of confidence. So
consumers cut back on expenditures and investors cut back on expenditures. Confidence is
very hard to model. The stock market crash must have played a very important role in this
decline of confidence. But as I noted before, the 1987 crash had no such effect. An
important difference between now and 1929 is that we're no longer on fixed exchange rates
and the Fed does not need to pursue a tight monetary policy as it did in the early 1930's.
I think that the Fed would take action to prevent a real depression. But a recession is
quite a possibility.
Moderator at 3:50pm ET
What has been Alan Greenspan's role in the current market?
Robert J. Shiller at 3:50pm ET
Alan Greenspan began his Fed chairmanship just before the 1987 crash and he showed his
willingness to use his monetary policy tools to prevent a major meltdown in a stock
market.
Robert J. Shiller at 3:51pm ET
The fact that the economy rebounded so quickly from the 1987 crash is an important factor
in the widespread belief that any drop in the market must soon be reversed, and hence is a
factor in producing the very high market that we see today.
Robert J. Shiller at 3:52pm ET
A lot of attention is focused by market analysts on whether or not there will be a 25 or a
50 basis point rate increase at the next Fed meeting. I think that such concerns are
exaggerated in judging the market. The important thing is people's perception of
Greenspan's overall stance towards the stock market.
Robert J. Shiller at 3:53pm ET
Inflation fears are rising and economic growth is still scorching ahead. How do you see
things unfolding on the stock market in the near future?
Robert J. Shiller at 3:54pm ET
The decline in inflation that we've seen since the early 1980's has been an important
source of strength for the markets. I think the public tends to overreact to good
inflation news. Conversely, they may overreact to bad news on the inflation front. The
pick up in inflation that we saw in the first quarter of this year is a source of concern
for the market outlook. Chances are it's just an inflation blip, but if it gathers steam,
it could be a factor that changes market momentum.
k.zuckerbrot from gj.com at 3:54pm ET
Do you view bonds as an alternative to stocks in the burst bubble model or do you expect
them to decline along with stocks?
Robert J. Shiller at 3:56pm ET
In the 1987 crash, the stock market went down and the bond market went up, and that was a
flight to quality story. That's possibly what might happen again. I think investors should
of course diversify across many assets including bonds. Any such negative relation will
help diversification. I might also add that most investors seem unaware of
inflation-indexed government bonds, which are yielding around 4%, and these are riskless.
Many investors should be holding more of these than they are.
Moderator at 3:57pm ET
We're nearly out of time. Do you have any closing thoughts?
Robert J. Shiller at 3:58pm ET
I think maybe just a feeling of concern that some people who are taking excessively
concentrated exposures in the stock market right now might get hurt, and the pain extends
to others in their families. Some people are borrowing home equity loans and student loans
to buy stocks. Those people who take extreme positions to buy stocks stand to suffer the
most if there is a major market drop.
Moderator at 3:59pm ET
I'm sorry, but we're out of time. Thanks so much to our guest, Robert J. Shiller, and to
all of you for your great questions.