Irrational Exuberance

By history's yardstick, Shiller believes this market is grossly overvalued, and the factors that have conspired to create and amplify this event--the baby-boom effect, the public infatuation with the Internet, and media interest--will most certainly abate. He fears that too many individuals and institutions have come to view stocks as their only investment vehicle, and that investors should consider looking beyond stocks as a way to diversify and hedge against the inevitable downturn. This is a serious and well-researched book that should read like a Stephen King novel to anyone who has staked his or her future on the market's continued success. --Harry C. Edwards

Product Description
In this timely and prescient update of his celebrated 2000 bestseller, Robert Shiller returns to the topic that gained him international fame: market volatility. Having predicted the stock market collapse that began just one month after the first edition was published, he now expands the book to cover other markets that have become volatile, particularly the recently red-hot housing market. He includes a full chapter on domestic and international housing prices in historical perspective.

Shiller amasses impressive evidence to support his argument that the recent housing market boom bears many similarities to the stock market bubble of the late 1990s, and may eventually be followed by declining home prices for years to come. After stocks plummeted when the bubble burst in 2000, investors moved their money into housing. This precipitated the inflated real estate prices not only in America but around the world, Shiller maintains. Hence, irrational exuberance did not disappear—it merely reappeared in other settings.

Building on the original edition, Shiller draws out the psychological origins of volatility in financial markets, this time folding real estate into his analysis. He broadens the evidence that investing in capital markets of all kinds in the modern free-market economy is inherently unstable—subject to the profoundly human influences captured in Alan Greenspan’s now-famous phrase, “irrational exuberance.” As was true of its predecessor, the second edition of Irrational Exuberance is destined to be widely read, discussed, and debated.

This begs the question of why a bubble emerged in the late 1990's. Shiller discusses several cultural factors such as the ever-higher profile of the stock market in the media, including the Internet.

This begs the question of how it is possible for so many people wrongly to be optimistic about stocks. Shiller cites many findings in psychology, such as Asch Conformity, to explain how people can listen to others against their own best judgement.

This begs the question of whether it could be Shiller who is irrational. Shiller examines and refutes the arguments that pundits have made to rationalize exuberance.

There are three audiences for this book, all of whom will find it threatening.

1. Ordinary investors. You will not want to read this book, because it asks you to confront an issue that you would be more comfortable avoiding. However, once you do dive into it, you will be rewarded with sober facts and analysis that you can use to resist the siren calls of pundits, brokers, and friends to buy into the bubble.

I can assure you that Robert Shiller did not write this book to make his own fortune. The book jacket says nothing like "five strategies to survive the bubble," although he does mention some conservative investment alternatives. There certainly is no endorsement from Suze Orman or any of the other best-selling gurus that he swiftly skewers. This is just an honest book from a scholar with the highest integrity: an act of courage.

2. Economists. I can see a lot of squirming, particularly as Shiller discusses psychological studies that undermine the cherished rationality assumptions of our profession. Shiller is generous with those who disagree with him. He won't say it, but I will.

Shame on us.

Those of us who know better have been too silent. Paul Krugman wastes his bully pulpit in the New York Times discussing IMF esoterica, and only when Shiller's book came out did he mention the bubble.

Then there are those of us who don't know better. The hundreds of finance professor hacks whose tenure rests on mindless justifications and interpretations of irrational stock price movements. ("Events of type X create, on average, $Y of value." Oh, please.)

3. Policy analysts

This book certainly will not appeal to those who think that the biggest problem we are going to face in the next ten years is what to do with budget surpluses. Shiller correctly points out that the social security debate needs to be conducted, at a fundamental level, about what exactly we are promising ourselves. The trade-off between compassion and freedom must be faced. I wish he had illustrated this with a spectrum of alternatives--libertarian, socialist, and in between. This might have helped flesh out an otherwise terse discussion.


Speculating on a Bubble   March 25, 2000
Bruce I Jacobs (New Jersey, USA)
161 out of 200 found this review helpful

Speculating on a Bubble

Taking his cue from Federal Reserve Chairman Alan Greenspan, Yale economics professor Robert Shiller delivers a dirge for the longest-running bull market in American history. Irrational Exuberance tells the reader why today's market is overvalued, how it got that way, and what policymakers should do about it. Along the way, he takes some well-aimed swipes at efficient markets and so-called rational expectations. These latter theories, derived by (and largely confined to) academia, would have us believe that investors always behave rationally and that stock prices always reflect all pertinent information.

Professor Shiller is well known for his research into behavioral finance, including his many surveys seeking to uncover the thought processes of today's investors, both individual and institutional. It is understandable, then, that the bulk of the book, and its strongest part, concerns the ways and means by which human behavior, irrespective of economic fundamentals, leads to stock market bubbles. Peer pressure, herding, emotions such as regret and envy, perceptions shaped by personal contacts and by the media, all contribute to a psychological "positive feedback" loop whereby high stock prices beget still higher stock prices.

My gripe with the book relates to Professor Shiller's downgrading of the role played by mechanical "positive feedback" dynamic hedging strategies which are based on academic, Nobel Prize winning theories on the pricing of derivatives. Shiller states (p. 93) that these strategies are of interest to us "only because it shows us concretely how people's thinking can change in ways that alter the manner in which feedback from stock price changes affects further stock price changes, thereby creating possible price instabilities." My book, Capital Ideas and Market Realities (Blackwell, 1999), finds, after a thorough review of the role of dynamic hedging in the 1987 crash and in the volatility in the 1990s, including the downfall and Federal Reserve brokered rescue of the giant arbitrage hedge fund Long-Term Capital Management, that such trading strategies can be crucial elements in both stock market bubbles and stock market crashes. Rather than being merely symptomatic of a psychological feedback loop, such trading mechanisms create their own positive feedback loops, as well as crystallizing and amplifying some of the psychological factors cited by Professor Shiller.

Others may consider of greater consequence the book's failure to address the "two tier" nature of today's market-the so-called "new economy"/"old economy" schism. This is particularly troubling because much of Professor Shiller's quantitative evidence of over-exuberance in market pricing rests on various measures of corporate dividends-which, of course, are notoriously shunned by most "new economy" companies. As the book's overall argument can be (simplistically) summarized as "the future will eventually repeat the past," I would have liked to see him grapple more explicitly with what appear to be real qualitative differences between past and present.

I liked Professor Shiller's concluding summary of solutions and issues for investors and policy-makers. Some of these, including his thoughts on Social Security and on the need for diversification and diversifying investment vehicles, deserve to be brought to the forefront of public debate. It would also help matters if, as Professor Shiller suggests, the so-called "experts," as well as the media generally, raised the level of public discourse on the stock market and the economy-issues critical to all of us, whether we are investors or not.

Bruce I. Jacobs (cimr@jlem.com), Principal, Jacobs Levy Equity Management, and author of Capital Ideas and Market Realities (Blackwell, 1999).


Irrational Exuberance   March 30, 2000
Harvey S. Karten (Brooklyn, NY United States)
47 out of 49 found this review helpful

Robert J. Shiller's "Irrational Exuberance" is about the most bearish book you could ever read about the stock market. Filled with charts and graphs and footnotes of every description, the book--whose title comes from a quote by Alan Greenspan--attacks Wall Street ideas that have become so accepted that they are household sayings. The principal such idea is that securities have always been the best investments over the long run--beating out bonds, foreign currencies, rare stamps, gold and the like. Shiller points out quite a few examples of how market prices, principally the Dow, have remained pretty flat over some periods of 10, 20, 30 years when corrected for inflation. In some circumstances, you might have done better if you put your spare cash in the bank.

Of course the market has been a great place to stash your cash if you got in at the right time--in 1982, for example, at the very start of the longest-running bull market in history. But put your money there now at your own risk. Seventy-two percent of mutual fund managers believe that we're in a speculative bubble now, with the Dow, at 11,000, reaching for figures that far exceed the historic level which would put the rational figure at 6,000. Shiller would not be surprised if the Dow settled in at, say, 10,000--in the year 2020! And what's more, he'd not be astonished if the Dow sank to 6,000 in the near future.

I was convinced after reading Shiller. He has marshalled his facts in a carefully researched screed against following the sheep-like crowds and I have replaced the tens of millions I had invested in common stocks with far more secure, if less exciting, instruments.

Harvey S. Karten film_critic@compuserve.com


Is the stock market really overvalued?   April 15, 2000
David Roth (Oakland, CA)
41 out of 56 found this review helpful

Professor Shiller's excellent book provides food for thought, addressing the timely question of whether stocks are overvalued. He notes that P/Es are at historically high levels, and that high P/Es in the past have led to subsequent subpar returns, while low P/Es have led to excellent returns. For example, P/Es were high before the great depression, and low at the beginning of the eighties.

Shiller then goes on to explain a bit about the psychology of bubbles and manias, a field in which he is expert. He intersperses fascinating data that he has collected over the years, especially from the crash of '87, on whether market moves are due to the arrival of new economic information about firms' profitability or whether the market and its participants have a psychology of their own.

Still, I am not going to heed Shiller's advice to sell all my stocks right now. Before doing so, I would like to see him address the following issues (perhaps in Shiller's next best-selling book?):

(1) "The Fed Model" of stock valuations: Shiller uses P/E as a benchmark, rather than comparing yields available on stocks to those available on bonds. Greenspan's famous Irrational Exuberance speech used this benchmark rather than pure P/E (which doesn't compare stocks to alternative investments).

Also, is the nominal bond interest rate relevant for comparing stock to bond investing? The real interest rate? What have researchers discovered on this front?

(2) Shiller does not admit the possibility that there is anything different in today's economy from historically. I'm not convinced. Presumably, the following should be taken seriously, rather than dismissed out of hand:

First, firms are ramping up extremely rapidly in new industries, faster than ever before. It is quite reasonable to expect faster profit growth than the 11% long term average.

Second, reported profits are not what they used to be, they're better: Firms now expense R&D rather than depreciating it, and because R&D has been growing rapidly, reported profits are now much below what they would have been under old accounting standards.

Third, the cost of investing, especially of diversification through US and international mutual funds, has fallen precipitously, making stocks a more attractive investment.

Fourth, the world economy may very well be more stable now than in the past.

Fifth (and I have no idea if this is true), if people are really investing more for the long run than before, then their greater interest in stocks might be warranted, since stocks beat bonds much more consistently over long time horizons than over short horizons. Given this, it is important to know the source of the stock risk premium. Is it based on people's need for liquidity? Are people more or less in need of liquidity from their stocks now than tradiationally? How does the baby boom generation fit into all this?

Still, it's a fascinating book. Will the 35% fall in Nasdaq over the last few weeks be called the Shiller Effect a century from now?


Rational Expectations   April 5, 2000
Jim Sanders (Annandale, Virginia)
38 out of 42 found this review helpful

'Irrational Exuberance' will no doubt consolidate Robert Shiller's position within his chosen field, but the book is also of considerable value to the intelligent lay person. Other writers have drawn attention to the market's overpriced level. Other writers have also done the numbers and concluded that stock returns are not likely to out pace bond returns, for example, over the next decade. But no other writer provides such a detailed and convincing analysis of the factors that have stoked our mania for stocks and brought us to the top of a speculative bubble. Shiller's account of what academics such as Prof. Irving Fisher thought of stock market valuations in the 1920s is a useful reminder that even the experts can get it wrong. More importantly, his analysis of past decades suggests a cyclical movement in the all too human desire to believe in a new economic age. Among the truths which Americans evidently have not learned is that new economic eras do not result in permanent stock market booms. That technology enables more efficient production which in turn helps keep inflation low has been acknowledged publicly by Alan Greenspan. But the market's reaction extends way beyond what this fundamental change might warrant, for all of the reasons Shiller cites.

While Prof. Shiller's analysis is highly credible, his suggestions for the individual investor are, in places, difficult to understand. Indeed his discussion of diversification may only be deciphered by his fellow economists. Lay men and women can hardly be expected to know what "...taking short term positions in claims on income aggregates," means. Nor can they regard his advice to invest in markets that do not yet exist as practical guidance. These, however, are minor quibbles. Unlike many market commentators these days, Shiller's underlying social conscience puts him on the side of the little guy. Yet even so, this books is aimed primarily at policymakers who have the power to influence public behavior for the good. The prospect of thousands of retirees living on the margins because they invested too much of their 401(k) money in the stock market is surely one which will compel their attention.

Jim Sanders Annandale, Virginia