Irrational judgement drives stock market, expert says

When, in 1996, Federal Reserve Board Chairman Alan Greenspan used the term “irrational exuberance” to describe the stock market, Robert J. Shiller received a barrage of phone calls. A week before Greenspan made his speech,

When, in 1996, Federal Reserve Board Chairman Alan Greenspan used the term “irrational exuberance” to describe the stock market, Robert J. Shiller received a barrage of phone calls. A week before Greenspan made his speech, Shiller spoke in front of Greenspan and the other members of the reserve board, prompting some to think Shiller may have coined the phrase.

While Shiller didn’t come up with it, he used the term as a title for his book, published in 2000. The book came out around the time the Nasdaq dropped nearly 2,000 points in March and April of that year, making him seem like something of a visionary.

Shiller, a professor of economics at Yale, spoke to Temple students and faculty Wednesday about the economic factors that have defined the stock market’s history and those that will define its future. His talk was titled “Irrepressible Exuberance,” a variation on the title of his book that referred to the fact that despite the volatility of the stock market — especially over the last two years — people are still eager to invest.

Although he did not predict the 2000 crash specifically, he warned that investors, who put their money into overvalued stocks based on excitement and media attention, were causing stocks to be overvalued. When the actual values of stocks were realized, stock prices dropped sharply.

“People allow themselves to be influenced by what other people are paying attention to,” he said, discussing the prevalence of psychological factors in the stock market. “You have to know about the stock market to be respectable at cocktail parties.”

Irrational exuberance, as defined in Shiller’s book, is “wishful thinking on the part of investors that blinds us to the truth of our situation.”

The stock market itself, he said, is based on risk, but most investors do not realize this.

“Stocks are designed for people who can take and bear risk,” he said. Companies put the burden of risks on their stockholders. If a company does not meet its earning predictions, stockholders end up losing the most money.

This, he said, is why the exuberance embodied by many investors during the mid- and late-1990s was irrational, and the belief that the stock market was the best investment was creeping into American culture.

In a survey he has conducted each year since 1996, Shiller asks people whether they agree with the statement that “the stock market is the best investment for long term holders.” From 1996 to 2000, about 96 percent of the people he surveyed said they agree with the statement, a finding Shiller said shows the irrationality of investors.

The number of people who agree with the statement dropped to 91 percent in 2001, but this number is still much higher than it should be, he said.

A number of factors contributed to the irrational exuberance in the late-1990s, Shiller said, not the least of which was the emergence of the World Wide Web as a personal technology. The Web arrived suddenly and made a vivid impression on the public, even more so than technologies of the past, though he did compare it to the 1920s, when the telephone, radio and automobile were popularized, resulting in a similar stock market boom.

He listed other factors that played an important role in the late-1990s boom: a culture favoring business success, a republican congress, the baby boom generation, and 401(k) plans.

The 401(k) plans were developed in 1981 as tax-deferred savings plans. From the time of their inception to the early 1990s, the plans invested mainly in bonds. In the mid- to late-1990s, they changed drastically and began investing heavily in stocks. Shiller said this became a much riskier way to save for retirement.

“It’s amazing people don’t plan more for their retirement,” he said, adding that people often rely too much on Social Security. “There’s an exaggerated confidence that everything’s going to be great. People have given up on saving [money].”

Concerning forecasts for the stock market, Shiller said “the stock market may do very well in the next year” because “confidence is very high.”

Using a formula which includes the stock market’s Price/Earnings ratio, Schiller said the S&P 500 index, a group of stocks often looked to as an indicator of market behavior, would decline 4 percent per year for the next 10 years. Adjusting for inflation, this would leave the index at a value of about 900. Today, the index is valued at just over 1,100.

But Shiller noted that even professionals do not have concrete predictions about the market over a year’s time.

Aaron Bycoffe can be reached at

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