Customer Reviews

Irrational Exuberance

5 star:		(20)
4 star:		(19)
3 star:		(10)
2 star:		(5)
1 star:		(3)

 

 

This is a treaty on Behavioral Finance. Shiller makes a strong case that markets are not efficient, but respond to crowd psychology.

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.

I am not a financial expert. I have traded stocks, futures and index funds but that is the extent of my involvement with the market.

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

I have an advanced degree in economics and know Shiller's academic work, but I was pleasantly surprised that this was not too "ivory tower". Lots of facts and references to real world events make it more easily readable. The tone and sentence contruction does remind one of university days tho.

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.

Shortly after a briefing by author Robert Shiller, Alan Greenspan warned the country about the "irrational exuberance" pushing stock prices excessively high. The year was 1996 and, in hindsight, it's clear that the bull was just beginning to run. Anyone who heeded that warning would have passed up some of history's most impressive gains. Yet, if history is any guide, stock prices could be in for a 10 or 20 year decline, falling back below the bull market's gains. But Shiller isn't teaching market timing; he's debunking some cherished investing axioms, such as, the belief that stocks are the best long-term investment. He discredits financial reportage, limns to the psychological and emotional factors that make markets behave irrationally and proves that nothing is new about "new economy" prattle. The book is a very effective vaccination against the costly virus of credulity. We [...] suggest this book for every investor's shelf - dog-eared and worn from frequent re-reading.

The bearer of bad news in society, in a company, in a group is most of the time treated badly. This rule of human nature shows up in many of the previous reviews of this book. Given the decline in the equity markets since the publication of this book, the reason I am reading this book again is to consider whether the market correction is sufficient. The book originally contributed to my courage to be conservative on the market and hence was one of the most valuable books I have ever read.

On December 5, 1996 Chairman Alan Greenspan used the phrase "Irrational Exuberance" when speaking of his deep concern about the high level of stock prices -- not as a forecast but as a long term threat to economic soundness. Why Greenspan weakened in resolve, is barely addressed in this book. The question of why Greenspan started his Federal Reserve board tenure speaking gravely of the need for no inflation (meaning zero inflation not 2-3% inflation) and then weakened and accommodated 2-3% inflation for the next ten years is not even addressed in this book. The book even fails to address the impact on stock price levels of ten years of excessive monetary growth. The book clearly speaks to the public policy issue that there has to be a reckoning for the excessive stock price levels.

Having made my living in the stock market investment business for more than forty years, the book for me reads easily. I believe the average reader can get through the book with very few uses of a dictionary. It is well written for the average reader. It is cleanly organized. It starts out with a powerful statistical case. It follows with a review of nearly every imaginable consideration of the severity of general market volatility. The fourth chapter "The News Media" is written with such courage and clarity. It seems to me so profound-it by its self justifies the purchase of the book. It lays out the true motives of the media. Every citizen, investor or conservative saver should read it.

Several bone headed media people have argued that America's savings rate is seriously understated because stock market ownership is not included in the savings. After reading this book you should be able to vividly see the difference. If not already be thinking seriously as to when does the purchase of stocks become a speculation or out right gambling. Speculation is accepting high risk because it offers a risk reward balance. Gambling in stocks is not understanding this balance. Investing is buying with a basis for believing you have fair value in your favor. The discussion on gambling habits in society and the stock market is superb. The last chapter: A Call to Action "Speculative Volatility in a Free Society" is so pathetic in insight that I suggest that you read it first or forswear never to read it. Otherwise it is such a let down ending to the book as to be seriously irritating.

As the author has already been vindicated in the market place and the book is written in a scholarly manner, I can't think of any reason why an equity investor would not read this book. If you don't it seems that you would be in a state of denial. There are so many new avenues to consider in this book that it is one of those books that an investor will keep the rest of their life and read it several times.

The current importance of Professor Robert J. Shiller's prescient publication in March 2000, right near NASDAQ topping out around 5000, is to see what relevance it has for us today. He begins with 12 factors he believes played a major role in creating the bull market/boom/bubble of the late 1990s, and ends with an assessment of which of those 12 will continue to play an influential role going forward. That, too, should be our concern.
First, let me say that his deconstruction of the "efficient market theory" probably has more lasting importance in the financial world than his assessment of whether we had an overvalued stock market, and should be taken to heart by everyone who wants to make money in the stock market. In over a decade as a member of two securities exchanges, I never found any evidence that the random walk or efficient market theories had any significance in real world finance. An ivory tower construct, for sure.
Prof. Shiller's 12 reasons for the 1990s boom and their current/future influence:
1. The Internet: It remains a viable growth engine, but got ahead of itself. The Internet continues as a strong influence on business and the stock market.
2. Decline of foreign competition: Our victory over communist economies is waning. New competition (China) will emerge on the world scene.
3: Pro business culture: Could easily turn against the market.
4. Pro business governmental policies: Could easily turn against the market.
5. Life cycles - Baby Boomers: He expects the positive effect to diminish.
6: Financial press reporting: Probably will continue but not show much growth.
7: Optimistic analysts: Can easily turn negative.
8: Retirement plans: Social Security is a potential plus if redirected into stocks.
9. Growth of mutual funds: Difficult to ascertain.
10: Decline of inflation: Can't get lower; can only get worse.
11: Day trading/increased public participation: Likely to continue. More people's access could elevate prices.
12: Rise of national gambling culture: He admits the connection between gambling and the stock market is weak.
Prof. Shiller is pro-markets. His concern is whether outrage over the bursting of irrational bubbles might do irreparable harm including turning our society against our capitalistic and free-market institutions. On this point he eloquently states, "Speculative markets perform critical resource-allocation functions (a point I have taken for granted and have not focused on in this book), and any interference with markets to tame bubbles interferes with these functions as well. Ultimately, in a free society, we cannot protect people from all the consequences of their own actions. We cannot protect people completely without denying them the possibility of achieving their own fulfillment. We cannot completely protect society from the effects of waves of irrational exuberance or irrational pessimism - emotional reactions that are themselves part of the human condition." (p233).

Perhaps this is why under the subject of what role government might play in cooling down irrationality before it becomes destructive, I did not notice any reference to the FRB's role of setting margin rates on stock purchases. This power (Reg T) was created precisely to cool down speculative markets when they get too hot. Greenspan, for whatever reason, chose not to invoke this tool during the boom.
In the end, Prof. Shiller blames investors for their blind exuberance and predicts more difficult times ahead. Indeed, his fears have been borne out the past 3 years. But even he does not rule out another run based on new factors and old psychology because not only is it human to err, but also it is human to be irrational. The solution? In his words, "It may be that the best stabilizing influence on markets is to broaden them, allowing as many people to trade as often as possible." This is why in his next book, "The New Financial Order: Risk in the 21st Century" (2003) (see my review), Prof. Shiller confronts how government and society can work together to mitigate future emotional disruptions to our everyday lives through market-based instruments.

Stock markets are complex and mysterious creatures. Predicting their behavior is a fantasy that has persisted in investors' minds for ages, and various tricks have been conjured to anticipate (and profit) from stock movements. What all these techniques have in common in an expectation that markets can indeed be predicted-and that they all, invariably, fail.

Robert Shiller, of Yale University, contributes to this debate by canvassing the salient features that characterize the stock market. First, he argues that markets tend to be irrational: prices skyrocket based on frenzy, not fact. Price-earning ratios, for example, tend to move much higher than earnings, implying that expectations are not based on higher expected earnings. The same irrationality, Mr. Shiller continues, can be observed in the relation of stock prices to dividends: stock prices are more volatile than dividends, meaning that prices cannot be fully reflective of expected dividends, as the efficient market theory would predict.

So what determines stock prices then? This is the book's most creative part, at least for those familiar with economics but not psychology. Two factors, the media and "new era" thinking, tend to create an undue optimism about markets, causing prices to exceed rational limits. These two trends, however, are amplified by psychological phenomena: an overwhelming trust in the opinion of authorities, overconfidence in one's investment strategy, a linear reasoning that cannot be defended against uncertainties or complications, and so on.

Any reader should be impressed by the complexity and accessibility of Mr. Shiller's analysis. If his book is taken as a prognosis of the 1990's bubble bursting, then "Irrational Exuberance" is a timely warning that proved correct. But what makes this book a classic is its magnificent combination of economics, econometrics, sociology and psychology in analyzing the stock market. This much needed interdisciplinary work makes this book a must read for investors and policymakers alike.

As a insurance agent dealing with the public everyday, Robert Shiller has hit it right on. The 401k, new era thinking, and ponzi scheme like returns by new money coming in so fast, thus driving up returns artifically, all combined for this incredible run up. Also, I would be remiss if not adding in all the new "Financial Planners" which are nothing but mutual funds sales people and we can not leave out the talking heads that are on TV everyday. Watch who their advertisers are for a clue.

I can sell Life Insurance, Bank Products, Mutual Fund Products and I have only sold bond funds over the last 3 years thanks to Professor Shiller's back up. I had clients tell me with an attitude, just 2 years ago, that they would make 15% annually for the rest of their lives. I haven't seen them lately and I haven't seen anybody come in to pay back their cash value loans. What they have not learned is that "Wall Street" is about making money for "Wall Street" and not for the average investor.... Most people that I question do not even know what a PE Ratio is!! They are clueless and the "Wall Street Barrons" are taking their money.

Unfortunately, they don't know only the NASDAQ has blown up, stay tuned for the S&P and Dow as their day has not come yet! If you have any doubts or questions, Mr. Shiller's research nails it, stocks always come back to norm the problem is that time is unknown. Right on Professor Schiller!

I want everyone to go back and read the first review of this book buy David Roth in April of 2000. His pathetic "analysis" of the market perfectly captures the absurd psychology of investors in the bubble-era. His review alone shows the importance of this book.
-Dan

A must read for anyone who has begun to question the received knowledge about investing and the stock market (efficient market, 12% long range growth rate, etc.) A reality check for anyone who has believed the results of an online calculator from practically any popular "individual investor" web site and been confident their portfolio will last 30 years at a 7%-up withdrawal rate, and similar fables dished out by the popular press during the tech/Internet boom that just busted.

Fascinating book, sounds prophetic in places in light of current economic/market conditions.