January 19, 1999
Finance Guru Advises Stocking Us Against Risk
By Alan Schoenfeld
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As the stock market reached unprecedented heights in 1998, many Americans reveled in the success of their investments. One Yale economics professor, however, could only watch in amazement as his predictions were repeatedly proven wrong. Robert Shiller, GRD '82, Stanley J. Resor Professor of Economics and "the smartest guy who'd been most wrong about the stock market," according to Fortune, sat down with the Herald to discuss last year's economy and offer some predictions for 1999.
According to Shiller, the recent success of the stock market is fascinating because it defies many historical trends. "We're at an unusual point in history," Shiller said. "Historically, after a period of success on the stock market, the price goes back down. Currently, it's a little uncomfortable because it has never gotten this out of whack."
The dividend-to-price ratio, the stock market's indicator of how much money investors are earning on their investments, is now at a record low, under 1.3 percent--less than one third of what it should be, according to Shiller. "The stock market is way overpriced, and the prices just keep going up," Shiller said. "Right now, you can earn more on your savings account than in the stock market. Eventually, people are going to get sick and tired of getting only 1.3 percent. When the dividend-to-price ratio is really low, two things can happen to make it higher: either the dividends can increase or the prices can go down. Historically, when the ratio has been at extremes, the prices go down."
In December 1996, Shiller and a former graduate student testified before the association of governors of the Federal Reserve, predicting that the economy was due for a downturn. But since that time, the stock market has consistently grown in worth. "It seems that you could forecast one year easier than many years, but I don't think that's true," Shiller explained. "Everything is pointing to decline, though. I hate to say something as dramatic as this, but it is entirely plausible that the [Dow Jones] could dive well below 7,000 in the next few years."
This potential for economic Armageddon suggests a need for action. What does Shiller advise? "I would recommend getting out of the market, but I wouldn't do that, because any prediction is fundamentally uncertain," he said. "The advice I'd like to give is to remind people to diversify their investments: around the world, in real estate, in bonds, etc."
According to Shiller, the best investments available to Americans right now are the indexed government bonds the U.S. government began offering in January 1997. "The government promises the inflation-corrected value of the bond. There is absolutely no risk," Shiller said. Investors haven't yet snapped up this opportunity because, he explained, "People don't seem to be attracted to riskless investments. With the stock market doing so well, investments like indexed bonds seem to be so unexciting."
Although the American economy continues to grow, the global economy has experienced both successes and failures as it grows increasingly interdependent. Economic crises have frustrated Russia and Brazil, but at least, according to Shiller, the `Asian flu' seems to have worn off a bit. "The global economy is experiencing a lot of volatility, and no one is certain what is going to happen," Shiller said.
The advent of the euro has also attracted Shiller's attention. "Economically, the euro will have some advantages: restoring uniformity, simplifying transactions, et cetera. But I think it is of interest more because of the symbolic function of uniting the countries."
A few days after Shiller's 1998 testimony to the governors of the Federal Reserve board, in which he discussed the irrationality of investors, Reserve Chairman Alan Greenspan made his famous "irrational exuberance" speech. Though Shiller's predictions were slightly off the mark last year, the world-famous economist is sticking to his guns for the long term. "I'm not getting as many calls as I used to from journalists," Shiller said. "But we'll see whether I'm most wrong ultimately."