Irrational Exuberance
by Robert J. Shiller
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Book Summary Information
Author: Robert J. ShillerEdition: Paperback
Audio: English (Unknown); English (Original Language); English (Published)
Published: 2006-05-09
ISBN: 0767923634
Number of pages: 336
Publisher: Crown Business
Book Reviews of Irrational Exuberance
Book Review: How To Explain Investors' Behavior
Summary: 5 Stars
Robert Shiller starts his book by stressing the troubling lack of credibility of research and analysis being done on the stock market, to say nothing of the clarity and accuracy with which it is communicated to the public. "To be fair to the Wall Street professionals whose views appear in the media, it is difficult for them to correct the basic misconceptions about the market because they are limited by the blurbs and sound bites afforded them. One would need to write books to straighten these things out, writes the author. This is such a book."
Sometimes a picture or a graph is worth a thousand words. By plotting the S&P stock price index expressed in real terms or the evolution of price relative to earnings, Shiller vividly depicts the unsustainable nature of the high-tech boom that ended at about the time the first edition of the book was published. He also identifies three other episodes of grossly inflated prices: the Twentieth Century Peak of 1901, the market frenzy that ended with the Black Monday crash of October 28, 1929, and the go-go years of the 1960s. He characterizes these market episodes as speculative bubbles--unsustainable increases in price brought on by investors' buying behavior rather than by genuine, fundamental information about value.
There is always a vast supply of theories in bubble times to justify the market heights and to nurture bullish views about the future. Shiller lists several factors that plausibly caused the market to climb in the last recent episode of "irrational exuberance": the arrival of the internet, the decline of foreign economic rivals, the surge in materialistic values, the growth of mutual funds, the expansion of defined contribution pension plans, the decline of inflation, the declining cost of making a trade, and others. Each factor played a role and they certainly reinforced each other in a unique combination, but, as the author notes, most of them are one-off events and they do not by themselves justify a radical departure from the past or the dawn of a new era of permanently high prices. Indeed, Shiller shows that the belief in a radical change in the rules of the game, what he calls `new era economic thinking', accompanied all previous market peaks in US history.
Whet makes people receptive to these optimistic statements is not, as the title of the book would suggest, a kind of irrational exuberance or collective madness, but is rather to be found in patterns of human behavior identified by psychological research. People tend to make judgments in uncertain situations by looking for familiar patterns and assuming that future patterns will resemble past ones. They need psychological anchors to determine whether stocks are priced right or when to enter and exit the market. They hold beliefs which they like to see confirmed, and the media industry can slant stories toward these beliefs. Indeed, the media and the investment community have an interest in encouraging conventional wisdom about the market and exploiting the get-rich fantasy. As the author notes:
"People writing for or quoted in the media regularly pose the question, after a big one-day decrease in the market, of whether this time the market has `found its bottom' or, after an increase, whether the market has `begun a long-term rally'. The symmetrically opposite questions seem never to be asked. One never sees media accounts after an increase inquiring whether the market has `found its top' or, after a decrease, whether the market has `begun a long-term decline.'"
The conclusion is cautiously optimistic: if reasonable attitudes toward risk and return are promoted by opinion leaders and transmitted through word-of-mouth or by virtue of example, the general public will `unlearn' some basic misconceptions about the stock market and will take proper steps to protect their existing wealth from excessive risk. No doubt this book will have contributed to this result.
Summary of Irrational Exuberance
As Robert Shiller?s new 2009 preface to his prescient classic on behavioral economics and market volatility asserts, the irrational exuberance of the stock and housing markets ?has been ended by an economic crisis of a magnitude not seen since the Great Depression of the 1930s.? As we all, ordinary Americans and professional investors alike, crawl from the wreckage of our heedless bubble economy, the shrewd insights and sober warnings, and hard facts that Shiller marshals in this book are more invaluable than ever.The original and bestselling 2000 edition of Irrational Exuberance evoked Alan Greenspan?s infamous 1996 use of that phrase to explain the alternately soaring and declining stock market. It predicted the collapse of the tech stock bubble through an analysis of the structural, cultural, and psychological factors behind levels of price growth not reflected in any other sector of the economy. In the second edition (2005), Shiller folded real estate into his analysis of market volatility, marshalling evidence that housing prices were dangerously inflated as well, a bubble that could soon burst, leading to a ?string of bankruptcies? and a ?worldwide recession.? That indeed came to pass, with consequences that the 2009 preface to this edition deals with.
Irrational Exuberance is more than ever a cogent, chilling, and astonishingly far-seeing analytical work that no one with any money in any market anywhere can afford not to read?and heed.
CNBC, day trading, the Motley Fool, Silicon Investor--not since the 1920s has there been such an intense fascination with the U.S. stock market. For an increasing number of Americans, logging on to Yahoo! Finance is a habit more precious than that morning cup of joe (as thousands of SBUX and YHOO shareholders know too well). Yet while the market continues to go higher, many of us can't get Alan Greenspan's famous line out of our heads. In Irrational Exuberance, Yale economics professor Robert J. Shiller examines this public fascination with stocks and sees a combination of factors that have driven stocks higher, including the rise of the Internet, 401(k) plans, increased coverage by the popular media of financial news, overly optimistic cheerleading by analysts and other pundits, the decline of inflation, and the rise of the mutual fund industry. He writes: "Perceived long-term risk is down.... Emotions and heightened attention to the market create a desire to get into the game. Such is irrational exuberance today in the United States."
By history's yardstick, Shiller believes this market is grossly overvalued, and the factors that have conspired to create and amplify this event--the baby-boom effect, the public infatuation with the Internet, and media interest--will most certainly abate. He fears that too many individuals and institutions have come to view stocks as their only investment vehicle, and that investors should consider looking beyond stocks as a way to diversify and hedge against the inevitable downturn. This is a serious and well-researched book that should read like a Stephen King novel to anyone who has staked his or her future on the market's continued success. --Harry C. Edwards
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