Bubble mania

Scott Sumner has a post over at Econlog “Endless bubbles”. He´s still trying to find an occasion when Robert Shiller recommended being long stocks…The only reference to “buying stocks” by Shiller I found was this from a Davos interview last January:

Nobel prize-winning economist Robert Shiller told CNBC at the World Economic Forum that he is still investing in the stock market despite warning of bubble-like conditions.

Shiller said that his own long-term valuation metric for stock markets, which measures price-to-earnings based on average inflation-adjusted earnings over the previous 10 years, was currently high at 25. But it was still well below the record high of 46 reached in 2000.

The most famous “bubble occasion” was back in 1996.

WSJ “Greenspan Pops the Question: Is the Stock Market Overvalued?” (December 1996)

WASHINGTON — On the morning of Dec. 3, 1996, having watched the Dow surge a dizzying 27% that year, Federal Reserve Board Chairman Alan Greenspan hosted a private meeting that became his own genteel version of the debate show “Crossfire.”

On one side was Abby Joseph Cohen, the belle of the bull market, who came from her post at Goldman, Sachs & Co. to defend investor sanity. She methodically gave Fed governors a list of reasons why underlying economic changes justified such lofty prices in the market.

On the other side were two Ivy League economists, Yale’s Robert Shiller and Harvard’s John Campbell, who painted a much gloomier picture, though they didn’t address Ms. Cohen’s comments directly. They illustrated their message of portent in 10 pages of handouts showing trends going back to 1872. The markets were destined, at best, to tread water, and possibly to crash, they warned.

As unusual as that meeting was, it didn’t compare to what would follow two days later. At a black-tie banquet at the Washington Hilton, Mr. Greenspan delivered a speech that would contain the most memorable utterances of his career: “How do we know when irrational exuberance has unduly escalated asset values? … And how do we factor that assessment into monetary policy?”

Minutes after he spoke, stocks began tumbling in Tokyo, where the markets were open. That was followed by more carnage in Europe, then the U.S. Over the next few weeks, the Dow Jones Industrial Average slipped 4% from its then-record of 6400. Back at Yale, Prof. Shiller’s wife penned a Christmas letter to friends: “Recently, Bob has been troubled by the thought that he may have caused a worldwide stock market slide.”

Other notable examples.

Krugman in “Ice Age Cometh” (May 1998):

The more I look at the amazing rise of the U.S. stock market, the more I become convinced that we are looking at a mammoth psychological problem. I don’t mean mammoth as in “huge” (though maybe that too), but as in “elephant”. Let me explain.

If you follow trends in psychology, you know that Freud is out and Darwin is in. The basic idea of “evolutionary psych” is that our brains are exquisitely designed to help us cope with our environment – but unfortunately, the environment they are designed for is the one we evolved and lived in for the past two million years, not the alleged civilization we created just a couple of centuries ago. We are, all of us, hunter-gatherers lost in the big city. And therein, say the theorists, lie the roots of many of our bad habits. Our craving for sweets evolved in a world without ice-cream; our interest in gossip evolved in a world without tabloids; our emotional response to music evolved in a world without Celine Dion. And we have investment instincts designed for hunting mammoths, not capital gains.

The Economist “America´s bubble economy” (April 1998):

AN ECONOMIST, it is said, is an expert who will know tomorrow why the things he predicted yesterday did not happen today. So what will be tomorrow’s explanation of why share prices continue to soar today despite frequent warnings from many commentators (including The Economist) that Wall Street is overvalued? The most popular explanation within America is that it has entered a new economic era of faster, inflation-free growth, and hence stronger profits, thanks to new technology and globalisation. We beg to differ: America is experiencing a serious asset-price bubble.

The charts depict the stock market (S&P) in both nominal and real (inflation-adjusted) terms and Shiller´s 10 year trailing P/E ratio. Bubbles or Macroeconomic Fundamentals? Take your pick!

Bubble Mania_1

Bubble Mania_2


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