INTERVIEW
Who Says This Stock Market Is
Overpriced?
The market is now near its all-time highs. Yet, says Nobel
laureate Robert Shiller, that doesn’t mean a turnaround
is in the cards.
By
LESLIE P. NORTON
Oct. 14, 2017 12:51 a.m. ET
Derek Dudek for Barron’s
As the 30th anniversary of the 1987 stock market crash neared, Robert Shiller, the Nobel laureate and
Yale University economist, mused on why today’s seemingly overpriced market continues to
sleepwalk higher. The cyclically adjusted price/earnings, or CAPE, ratio that he and John Campbell
devised in the 1980s is at its highest level ever, with two exceptions: shortly before the 1929 crash,
which set the Great Depression in motion, and shortly before the dot-com bust. (The CAPE, which is
based on average inflation-adjusted earnings over the trailing 10 years, stands at 31, versus 32.5 in
1929 and 44 in late ’99.) Investors’ behavior today, Shiller says, is shaped by a number of narratives
that keep them in the market, including fears that robots will displace jobs and hopes that the Trump
administration will stoke the economy.
RELATED:
“Thaler’s Nobel Boosts Behavioral Economics”
Shiller was early to the study of behavioral economics, a field for which his friend Richard Thaler
won the Nobel Prize in economics last week. Lately, Shiller has been investigating how narratives
help shape sentiment. Keep reading to learn more about narrative economics, long-term returns—and
the importance of the 1890s depression.
Barron’s: Richard Thaler just won the Nobel Prize in economics. The academy cites him and
yourself as the founders of behavioral finance.
Shiller: I am very pleased. He is one of the most important economists of our generation. His work
has a real potential to help society. His book Nudge, with Cass Sunstein, shows a number of avenues
for real advances in human welfare.
What are your thoughts as the 30th anniversary of the 1987 crash nears?
It seems like yesterday. One parallel is that most people think the stock market today is overpriced. I
mailed out questionnaires a few days after the Oct. 19, 1987, drop, trying to probe what institutional
and individual investors thought on the day of the crash and leading up to it. They thought the market
was overpriced. And the P/E ratio wasn’t at all as high then as it is now. It’s a matter of perception.
You have to focus on what people think. I’ve emphasized the importance of stories.
How about today?
You can compare today with 1929, a boom year before the market peaked. Clarence Barron believed
the experience of World War I strengthened people psychologically. He said, “Every war stimulates
the energies of the people, increases their daring, their spirit of adventure, and takes away the fear of
borrowing. The result is that business conservatism is thrown to the winds, and borrowing and
construction continue on the basis of hope.” Irving Fisher wrote glowingly of technological progress
and more-efficient industry. But the other side was that the market was getting pricy. People called it
a casino.
In 1929, trying not to be alarmist, the Federal Reserve issued a carefully worded statement that the
extent of margin was excessive. There was more fear that there would be a major correction.
Today, people have heard it said enough times that the market is unambiguously overpriced. The
CAPE ratio is now at 31. The 10-year forecast based on CAPE is positive, but not a whole lot above
zero. We’re in a different social environment. The narrative today is Donald Trump. It is a pro-
business narrative, which I infer from his books, such as Trump: How to Get Rich. People aren’t in
the frame of mind that we should worry about a crash.
Is it time, then, to discard the CAPE as a predictive tool?
Well, I wouldn’t. It may yet do that [be correct]. Today, there’s the idea that you can ride through the
ups and downs of the market and do great. There’s also a new narrative that’s rapidly gaining
strength about robotics and artificial intelligence as fearsome forces. That has people wanting
investments that will survive the robotic stage. That makes them interested in the FANGs and tech
stocks, because they are grasping for something to help them survive, what with voice-recognition
software, translating programs, and driverless cars; and now they are developing crewless ships to
sail cargo across the ocean.
These narratives may not dissipate fast, and people get repeated shocks of new technology that scare
them. One perfect narrative is Bitcoin: It encourages people to want to master cryptography and
math. Young people are identifying with it.
What is narrative economics, and why is it important?
The economics profession likes to be able to forecast gross domestic product and unemployment and
interest rates and all those things without looking at psychological forces. It’s considered a
mathematically precise discipline. John Maynard Keynes argued that we should also consider animal
spirits. I wrote a book with George Akerlof with that title. Narrative economics says that animal
spirits change through stories, especially in human-interest stories.
“ “One parallel is that most people think the stock market today is overpriced….And the P/E
ratio was not at all as high then as it is now. It’s a matter of perception. You have to focus
on what people think.” –Robert Shiller”
For example, you’re probably tired of hearing about Trump. I was reading recently about Williams
Jennings Bryan and the 1890s depression. Bryan was a brilliant speaker, like Trump. Newspapers in
the 1890s used almost that wording, that all people want to talk about is William Jennings Bryan.
Some people said that he was an idiot, that his facts were wrong, and that the people who believed in
him were riffraff. The self-styled intellectuals supported McKinley.
Right now, there’s still optimism about Trump, that he will cut corporate taxes and support business.
That could go on, unless it starts to look like he doesn’t have the touch that he described in The Art of
the Deal.
Why is the depression of the 1890s germane?
It had the same fractious split in the population, with urban Easterners accusing rural Midwesterners
of stupidity, and because the Midwesterners and Westerners tended to go for Bryan, just as they now
go for Trump. Bryan took over the Democratic Party, many said then, without regard for its values,
just as Trump has with the Republican Party.
Will narrative economics help economists be better predictors?
I’m writing a book about this now. We have to not be so mechanical. I’m trying to understand past
events using word counts, using textual analysis, to get some idea of what people were talking about,
and then reading what they said.
For example, I’ve been reading about bimetallism in the 1890s. In 1890, if you wanted to convert
your dollars into gold, you went to Federal Hall, opposite where the New York Stock Exchange is
now, and brought $20 in either silver dollars or paper money, and they gave you the gold. The
general public didn’t see gold dollars and thought we were on a silver standard. There was a
bestselling book in 1894 called Coin’s Financial School. [The book, written by a Bryan supporter,
argued that the demonetization of silver led to the panic of 1893, and that a return to a monetary
standard based on both gold and silver would revive the economy.]
In the book, a boy named Coin outsmarts the financiers many years senior to him. It reminds me of
the Bitcoin narrative: Most Bitcoin enthusiasts appear to be young and sure of themselves, like Coin.
Also, the book is smart-alecky, and with so many illustrations reminds me of a graphic novel, the
kind of presentation that brings on the real enthusiasm I detect among young people attracted to
Bitcoin. The depression of the 1890s took place because all these fears about inflation, and associated
unrest, took hold and tanked the economy.
We learn from reading history. We’re entering the realm of Big Data. We’re going to have a lot more
textual analysis tools. We are going to have semantic search. In the foreseeable future, we’ll need
economic historians. This is not to say we don’t need economic theory—we need both.
Where do you see the economy going?
Interest rates are at such extreme lows for longer than ever before. The other time short rates were
very low was the Great Depression. That ended with World War II, so it doesn’t provide a helpful
example. The Fed has embarked on a slow process of raising interest rates and of unwinding
quantitative easing. It is turning out to be very slow. We don’t know what will happen in this
unwinding. There could be a crash in the bond market, though I don’t know how to forecast things
like that. Rates have been declining for 30 years. The best they can do is stay low.
The idea of secular stagnation, coined by [economist] Alvin Hansen in 1938, may be right. Trump
has stimulated our animal spirits, but that could revert back. People could start cutting back on their
spending, and that would bring on another recession. There could be a new narrative that I can’t
predict, maybe just new stories about artificial intelligence and robots that may make people worry
and cut back spending.
What will cause the next bear market?
The next big crash occurs when people think other people are changing their minds. I don’t have a
precise way of forecasting. It could come soon. Stock-price volatility is lower on average in the year
leading up to the peak month in the previous bear markets. The volatility picks up as a bear market
develops. And earnings growth has been strong over the past year. That doesn’t mean you should be
confident about the market. Earnings growth was almost 20% in the year before the 1929 peak. Also,
1929 was a year of high earnings growth and somewhat low volatility, and it didn’t make any
difference.
How about the housing market?
The S&P Case Shiller Home Price Index is above its previous peak, but not in real terms. It has been
going up pretty strongly since 2012. The enthusiasm doesn’t seem the same as the enthusiasm around
the real estate boom in 2004. I did surveys of home buyers around ’03, ’04, ’05. Their expectations
for annual home prices were in the double-digit range going out 10 years. I think the fear of
computers or robots today is encouraging some to buy a house or land. The American dream is also
partly about home ownership.
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