Irrational Exuberance [Hardcover]

Shiller rebuts the Efficient Market Hypothesis. He has analyzed many U.S. stock market crashes. In each case, he did not find information absorbed by institutional and individual investors that justified the market downturns. In all cases, it appears the investors were "aware" of the reasons for the market downturn as explained by the financial press after the downturn occurred. For Shiller, this means that the reasons were false, and that investors do not digest information in such an efficient and immediate way as stated in the Efficient Market Hypothesis.

Shiller believes investors are irrational, and trade based on certain premises such as herd instinct, momentum, belief that stocks always go up. These beliefs are reinforced by the media. The resulting market valuation at the time the book was published (first quarter 2000, the market's peak) was far above its intrinsic value. As they say, the rest is history. Shiller's timing was perfect. We have been in a Bear market ever since.

Having said that I think it is not necessary to be an expert to read and appreciate the book. In fact the book uses a lot of common sense in its presentation of market data and the discussions of the data and the markets.

The most striking thing to me about the book is the description and summary concerning macro trends or cycles in the market. These cycles can extend decades. For example since approximately the late 1800's there have been five or six speculative bull runs to high market P/E values. The exact reason is different for each run up. We have seen run-ups due to the companies involved with railway stocks a century ago, the telephone as an investment tool in the 1920's, and then the new internet companies and trading electronically in the 1990's. The way stocks are bought and are sold and the financial instruments vary with the year or era. But these cycles repeat themselves every decade or two.

In almost every case investors participating in the speculative market spike or bull-run gets carried away and thinks this time, in this era, whether it was the 1920's or the 1990's that investing is now "different". The rules have changed. The high P/E ratios are now the norm. It is a "new era" and the old rules do not apply. Sound all too familiar? But in each and at every peak in the S&P or Dow, reality eventually sinks in, the investors pull back, and the market drops back to its historical average levels. That average level is a P/E ratio for the large cap or S&P 500 companies having an average P/E ratio in the general range of 10 to 20 or 25 maximum.

For some people foolish enough to invest near the market highs, and then who ride the market down have had to wait 20 years to see their stocks return to the same value at which they were purchased. Some stocks and companies do not survive the downturn and the investment vanishes. Now in our time one can only speculate on how many years or decades it will take for the NASDAQ to return to the 5000 to 5500 level.

This is sobering book, and it rates 5 stars for a short but excellent read and education.

Jack in Toronto

As one can expect, however, the key point that was missed is how to identify the characteristics of any future "irrational exhuberance" and thereby avoiding its perils. Basically, he segregates what does not cause bubbles, but then mixes into the possible causes a stew of multiple ideas. Anything clear and concise can't come from someone who doesn't take a view and stakes his reputation on it. That Shiller doesn't do.

I would give the historical work top scores, but current/future events are weak.