Nobel Laureate Robert Shiller says human nature, not China, explains market volatility
We asked Nobel Laureate Robert Shiller to help make sense of the U.S.’s volatile stock market. Photo by Spencer Platt/Getty Images
Editor’s Note: U.S. stocks rallied today after a turbulent week. The Dow Jones Industrial Average fell more than 1,000 points, before recovering briefly and eventually settling at a loss of 588 points for the day. On Friday, the Dow had lost 531 points.
We asked Nobel Laureate Robert Shiller to help make sense of the U.S.’s volatile stock market. While a number of economists and investors point to China’s slowing economy to explain the volatility, Shiller does not. What we saw, he argues, was the bursting of a speculative bubble.
Shiller, a Sterling Professor of Economics at Yale University, predicted the most recent housing bubble burst and developed the CAPE Index, which measures the price of a stock to its earnings over a 10-year period. Shiller has written widely on financial markets, macroeconomics and behavioral economics, most recently in his new book “Phishing for Phools.”
— Kristen Doerer, Making Sen$e Editor
What happened to U.S. stocks in the past week?
I would say that we saw the bursting of a speculative bubble, as it has been defined in much discourse and which has happened many times in history. But one must remember that the word “bubble,” if taken as a metaphor, can be misleading. A speculative bubble does not burst irrevocably or all at once as a soap bubble does. It may go on in a number of steps down, interrupted by upswings. I would say that a speculative bubble rises upon investor enthusiasm, and when it becomes too big, many people begin to have their doubts and contemplate selling, but don’t have clarity enough to actually do it. But when they see the market dropping, they begin to fear that others have the same doubts, and so many of them hurry up, trying to sell before the others do. So, the downswing can be surprisingly fast, recalling the bursting of a bubble, even if it is not quite as sudden as that.
Is this a reaction to what’s happening in China? If so, why?
I cannot imagine the news from China could provide a rational explanation for the drop in world markets. The news from China is too subtle, not that dramatic and sudden. But the story has been put forth by the news media as if it were suddenly extremely important, as part of a general pattern of news media and investor advice hype. In our new book “Phishing for Phools: The Economics of Manipulation and Deception,” George Akerlof and I use the word phishing more broadly than usual to describe such behavior. A phool is someone, who may be highly intelligent, but who does not see that he or she is a phish. A lot of people who bid up stock prices to such high levels were phools.
For those of our readers who don’t know your CAPE Index, can you explain what it measures and its importance?
CAPE stands for Cyclically-Adjusted Price-Earnings. It is a modification of the traditional price-earnings ratio to smooth out the cyclical or irregular jumps in earnings that occur from time to time. My colleague John Campbell of Harvard University and I developed it in the late 1980s, after we discovered that it really does help forecast long-term returns on investments, if not short term. We found that when CAPE was high, stock market investments don’t do well over the next 10 years or so.
What was you CAPE index today, and what does that number suggest? Are we seeing the deflation of a bubble?
In July, the CAPE index stood at 27, higher than at any time around 1929, 2000 and 2007. As of Monday, August 24, the CAPE ratio stood at 24. That is still quite high by historical standards. The average CAPE from the years 1881 to 2014 was only 17. This means that the stock market is still pricing quite high and likely to disappoint long-term investors, even if we cannot say what it will do tomorrow or next week.
What would you tell everyday investors who are suddenly seeing their life savings fall?
It is an occasion to look over their portfolio carefully, to see that it is properly diversified. If the portfolio is heavily into stocks, this might be the time when one has the emotional energy to take a careful look at it and maybe adjust the exposure down. I believe that it is important even for investors with only modest portfolios to seek out the help of a financial adviser. I would ask friends to recommend an adviser, who have had experience with someone who is trustworthy. In one’s portfolio there may be subtleties, and not just about speculative bubbles, including as well such things as taxes or retirement or estate planning that one can easily miss.
Is there any way to tell what will happen next?
The future is always uncertain. No one can forecast what will happen to the stock market tomorrow.
Is there anything else that you think we should be paying attention to or should know?
I have since 1989 been calculating a Stock Market Valuation Confidence Index that you can find on the Yale School of Management website.
I ask participants in my surveys, both individual and institutional investors, whether they think that the stock market is too low, too high or about right. The confidence index is the six-month average of the percent of them who do not think it is too high. As of last month, the index is at its lowest since around the time of the big 2000 to 2003 stock market crash. So, we can see that people indeed have been extremely doubtful lately about the market. It is only just now that many of them are selling. Why did they continue to hold if they were so doubtful? That must have something to do with human psychology and human nature. Most of us postpone considering difficult decisions until we think there is a sudden emergency.
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