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The stock market is still prey to "irrational exuberance," even though volume and prices have ebbed somewhat, and further declines are coming. That's the view of Robert J. Shiller, author of the much-discussed recent book, Irrational Exuberance -- a title drawn from a phrase used in a 1996 speech about the market by Federal Reserve Chairman Alan Greenspan.
Shiller, who is a professor of economics at Yale, expects a lot of volatility and poor performance over a number of years -- but no big bang. However, if confidence in the economy erodes, there could be a recession and maybe a market drop. Long-term trends of economic history point in that direction.
The author sees the computer and such related phenomena as online trading and day trading as contributing to market volatility, but he thinks today's New Economy was preceded by earlier "new economies" that were at least as important, generated by the automobile, the telephone, and the interstate highway system,for example.
These remarks were made in an online chat June 1 on America Online presented by Business Week Online, in response to questions from BW Chief Economist William Wolman, Jack Dierdorff of BW Online (the moderator), and the online audience. Here are edited excerpts from the chat. For a full transcript on AOL, go to keyword: BW Talk.
Q: Has anything happened in the market since your book went to press that has altered your views in any way? A: I signed off on my book Feb. 8. The Nasdaq peaked Mar. 10. My book hit the shelves Mar. 22. Around that time, volume and prices were extremely high. The tenor of the market has changed, with lower volume and somewhat lower prices.
Q: Typically, in a bear market, stock prices go up sharply on occasion and retrace part of the decline -- maybe as much as 50% or more. If the Nasdaq continues to rise for the next week or so, would you view this as a bear market...?
A: These week-to-week movements don't affect my longer-term judgments and are not meaningful in my view.
Q: How much has day trading and momentum investing contributed to the "irrational exuberance" of the market today?
A: Day trading is a phenomenon encouraging investor attention and therefore [bringing] demand to the market and encouraging higher volatility. Online trading is a growing phenomenon whose importance will be even greater in coming years.
Q: I've heard some analysis that the market today is at the levels where it was in the year leading up to 1929. Any truth to this? And are we in a bubble? A: Yes, I believe we are in a bubble, and yes, the [relative] stock market levels are as high as, or higher than, 1929.
Q: Bob, are you aware that in 1929 the stock market was up 9% for the year?
A: The Oct. 28-29, 1929, crash was completely reversed by Apr. 10, 1930. The market has always had surprising ups and downs. The significant thing about 1929 is that the Dow fell 86% from September, 1929, to June, 1932. It's not the short-run fluctuations that matter, it's the broad movements over longer time intervals.
Q: There are those who say that the current technological revolution is more profound than any in the past and that it has led to an acceleration in productivity growth. Do you believe that this is true? And if it is, how will it affect the market outlook?
A: ...In the long run, the computer may be the most important technological revolution. The computer was invented, by some accounts, in the 19th century. What's striking about the current market is the suddenness of the surge since around 1995, and this can't be explained by any sudden break in technology.
Q: BW claims credit for the concept of the New Economy. Do you think there is, in fact, a New Economy, and how does it affect market behavior and your expectations for what will happen? A: Of course there's a New Economy -- we are always moving into a New Economy. There was a dramatic New Economy when the automobile came in, and there was another New Economy when we built the interstate-highway system in the 1950s and beyond. These innovations changed the entire landscape of our economy and the spatial distribution of industries, and gave consumers many freedoms that they had never had before.... History is constantly bringing up "new economies."
Q: Do you see the entire market overvalued, or are there any safe havens for cash in stocks? A: I believe that the overall market is overvalued, but, of course, there must be individual stocks that are good investments....
Q: Do you think online chats such as this are part of the market hype that may be a problem?
A: The change in technology that allows online chats, as well as online trading, reminds one of the change in technology brought in by the telephone. The telephone first became important in the 1920s, and there were problems that sprang up as a result of the new technology -- the boiler rooms and the bucket shops. The new computer technology changes the nature of our communications in yet new ways, and we will have to learn how to live with this new technology.
Q: You were bearish on the market when it was in the 6000s. And you were wrong. What did you get wrong then? And could you be wrong now?
A: I wasn't wrong. I was giving a long-term forecast, 5 to 10 years, and I gave a margin of error. It never ceases to amaze me how journalists expect a forecaster to be right every time...
Q: You're not an investment strategist, but where else is there to invest money for the long term, if not the stock market? A: Well,...there are bonds, the money market, real estate, foreign assets, and we now even have inflation-indexed bonds that are riskless in real terms. One should diversify across many of these, and many of these are very attractive.
Q: In your book, you expressed the view that the Treasury's new inflation-indexed bonds were an attractive investment. Please elaborate.
A: ...The price level, the CPI, has been very unstable through much of history, and so conventional bonds have often been risky. For those people who are very risk-averse, the inflation-indexed bonds can be the perfect investment.... Currently, these bonds have been paying around 4% a year, with absolutely no risk. Compare that with stocks, whose dividend yield is around 1%, and with lots of risk. It is one of those great puzzles why so many people think that the only attractive investment is stocks.
Q: Not to pin you down to a specific forecast, but how much of a decline are you expecting, long term?
A: I can't be too precise -- and if I throw out a number, then people fixate on that. The Dow tripled in the last five years, and I think much of that was due to a speculative bubble. We could easily go back to one of its earlier values in that time period.
Q: What did Jeremy Siegel [author of Stocks for the Long Run] think of your book?
A: Jeremy and I used to be in complete agreement. I urged him to write his book in 1993. We have still been in agreement about Internet stocks. I'm more bearish for the whole market, certainly, but I think he likes my book.
Q: How will the current-account deficit affect market volatility and the dollar vs. the euro? A: The current-account deficit is part of the very strong and confident economy in the U.S.... This situation may not be sustainable. When confidence erodes, we may see a recession and/or an important stock market drop.
Q: What inspired you to write this book -- and where was the market when you started to write?
A: I started working on this book in 1987. However, I was interrupted by the crash of 1987, and decided then to work on a study of that crash. It was the advice of Jeremy Siegel that prompted me to take up work on it again in early 1999. I think that the stock market level is an important national issue that needs serious study....
Q: I know you don't want to forecast the market, but surely your views must have some implication for how investors should allocate their assets now. Any suggestions? A: ...I would say go relatively light on stocks now, except for special cases. I don't mean to lump all stocks together in all cases -- certain investments that are called stocks may have very different prospects. For example, we trade REITs on the stock markets, but they really represent real estate. There are, of course, no simple answers.
Q: Where do you see inflation headed? Do you feel that the Fed has taken appropriate measures to curb inflation?
A: I think the Fed has been handling inflation about right. They have been doing remarkably well in containing inflation. The 50-basis-point funds-rate increase in May was about what I would have done -- I might have gone a little bit more, but there's no real dispute here.
Q: [Do you see a Fed rate hike of] 50 or 25 basis points in June? A: I would guess 25, at this time. It depends on how the situation looks by then. We'll have another CPI report by June 28, and the Fed will adjust, depending on the new information.
Q: Were you ever bullish on the stock market? If so, when? A: Absolutely, I was! I was 100% in stocks from 1982 until around 1996. Jeremy Siegel and I were in complete agreement most of that time. I owe Jeremy gratitude for making me so much money. Stocks have been, usually, very good investments.
Q: Do you expect the air to go out of your bubble gradually, or with a bang? Are there any warning signs we should look for before running for cover? A: I expect a lot of volatility and poor performance, but no sudden bang. More down days than up days over a period of years -- that's the kind of end that might occur. You'll never see warning signs more than those we see today.
EDITED BY JACK DIERDORFF
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