Legends Of Indexing: Robert Shiller

December 22, 2014

This is the fifth in a series of interviews with some of the most influential people in the field of indexing and index-based investment. The interviews are also published in the November/December 2014 issue of the Journal of Indexes.

In 2013, Yale professor Robert Shiller was awarded the Nobel Memorial Prize in Economics alongside Eugene Fama and Lars Peter Hansen. Before that, Shiller was perhaps best known in the wider financial media for recognizing the housing bubble before it collapsed in 2006-07 and for his numerous books. However, in indexing circles, Shiller's name is well-known from the S&P Case-Shiller Home Price indexes, which he developed with Wellesley College's Karl Case.

This is probably a question you're getting a lot lately: Are we in a period of irrational exuberance right now?
I'm actually working on the third edition of my book, "Irrational Exuberance." Anyway, it's a matter of degree—it's a matter of percentages. The market has been going up rapidly and there is some exuberance behind that, I suppose. But it's not something that is uniform. There is a story at any time, and the story has multiple dimensions.

One thing that our story now is starting to share in common with the year 2000, which was the peak of the market in real terms—the 2007 peak didn't make it back up to that level, so I think of 2000 as a major turning point—is at that time, people were very concerned that the market was overpriced. We have been seeing increased concerns that that would happen; that is a sign of a bubble. If you're buying and holding the market but think it's overpriced, that might be a sign of irrational exuberance.

What is irrational exuberance? I think it's often a sense that the market always goes up in the long run, and it's hard to predict when it might go down, but it will surely come back up. So one question I have been asking in surveys is, "Do you agree with the following statement: The stock market is the best investment for long-term holders who can just buy and hold through the ups and downs of the market." Our agreement with that is going up, but it's not as high as it was in 2000. We're not quite in a 2000-like irrational exuberance, but we're moving in that direction.

In a recent interview, you basically said, "Don't pull out of the market." When would you exit the market?
Predicting turning points is an art, not a science, unfortunately, and not many people have much experience doing it, because major turning points are rare events. I'm thinking of past turning points—they seem in my mind to occur when there is a changing story.

There is always a story that drives markets, and that story changes. For example, in the 1920s, there was Coolidge prosperity and a sense that we are so much smarter and more sophisticated now. Industry was reorganizing itself in very productive directions. People were enthralled by the fact that they now had electricity and a radio and a car, and that was a new era. Then the story changed, so much that a significant number of Americans started to become communist. In the next decade, there was an era of communism in the United States. It was still never a majority, but we had a lot more of them then. A different story indeed!

I'm looking for changes in stories like that. We haven't had the most inspirational story lately, because there is still this nagging fear that the economy hasn't completely recovered and that there are still problems. It's not exactly the same kind of bubble at 1929. First of all, the market isn't as high, and secondly, it doesn't have the same fervor yet. It could keep going up. But the kind of thing that would change would be some new focus in the story.

There is worry now that is increasing about just long-term funks—what Bill Gross called "the new normal"—and that kind of story is gaining in people's imaginations, which could provide a sell signal. If you just read any article about the stock market, it tends to mention that it is five years after the crisis and we're still not really caught up. Things are disappointing all over the world. That is a story suggesting a turning point, and it might be amplified.

My theory is that stock price movement amplifies stories that explain that movement.

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