A Shiller Warning
David Warsh The Boston Globe, THE JOURNAL RECORD
If anyone can be said to speak for the accumulated learning of technical economics on the subject of today's stock market, it is probably Robert J. Shiller. He is centrally located in the profession: trained at Massachusetts Institute of Technology, professor at Yale University, a deacon of the famous Cowles Foundation for research in economics. He is distinguished: In 1996 his Market Volatility and Macro Markets won the first Paul Samuelson Award for the year's best writing on finance. He is practical, a partner in the prosperous firm of Case Shiller Weiss, which sells market data to real estate industry. He's still young enough (53) that when he makes a prediction his reputation is at stake.
Most significantly, he is self-aware. Shiller operates in the shadow of what surely is the most famous prediction by an economist in the 20th century. It was in October 1929 that Yale's Irving Fisher -- the best-known economist of his day -- pronounced his opinion that stocks had reached a new and permanently high plateau.
That he lost a considerable personal fortune in the ensuing crash only buttressed Fisher's place in history as a symbol of the shortcomings of economists. Yale had to buy his house to save him from eviction. The very real contributions Fisher had made to deepening economic understanding were overlooked for the rest of his lifetime.
Thus it is an event of some significance that Shiller has written a crystal-clear and tough-minded critique of the factors that have driven U.S. stock markets to their current levels and called his book Irrational Exuberance. In it, he argues that Federal Reserve Chairman Alan Greenspan had it exactly right when he uttered the famous phrase in a speech in 1996.
The current high levels of the market don't represent a consensus judgment by a cadre of sober experts, says Shiller. Instead, today's market is sky-high because of wishful thinking by millions of people, egged on by professionals in and around Wall Street whose incentives all run in the direction of the more the merrier.
The speculative frenzy is comparable to periods during which the stock prices peaked (measured in terms of price-earnings ratios) in 1901, 1929 and 1966, says Shiller. It simply is not likely to last. And though he is careful not to say when he expects the fever to break, he is clear that he expects it to happen within the next few years.
"There is a lack of sobriety about its downside and the consequences that would ensue" if the Dow Jones Insustrial Average dropped to, say, 6,000 and stayed there for some years, he writes. The harmful effects would be enormous -- to individuals, pension funds, college endowments and charitable organizations.
The Dow Jones Industrial Averaged tripled between 1994 and 1999. Nothing else in the economy tripled during those years. So Shiller surveys an even dozen factors he says have contributed to the self- fulfilling psychology of the bull market in stocks. Taken together, he says, they comprise the "skin" of the bubble.
* The arrival of Internet technology at a time when corporate earnings already were high has given rise to an exaggerated sense of technical change.
* The decline of foreign rivals and the resultant surge of American triumphalism has given rise to a pattern in which all news is viewed as good news.
* Cultural changes favoring business, trends in the compensation of executives in particular, has fastened ever-greater attention to market capitalization.
* A Republican Congress, having made capital gains tax cuts in 1997, has intimated the possibility of further cuts, leading investors to hold on to appreciated assents they otherwise might have sold.
* The sheer size of the generation of the baby boom is widely believed to have a salutary effect on the market. …