The Robert Shiller Interview: The Author of Irrational Exuberance and Yale’s “Top Gun” Fires Away on Real Estate Stocks and the Secrets of Investing
by Mark Skousen, Chairman, Investment U
Thursday, September 21, 2006: Issue #582
Last week I headed up to Yale University to interview Professor Robert Shiller, author of the now famous book, Irrational Exuberance. The book, which predicted that the “speculative bubble” on Wall Street could collapse at any time, came out in bookstores in March 2000, the exact peak.
Then in his second edition, which came out in 2005, he said that real estate was a similar “market bubble” that could be a “dangerous” investment. He again proved right in 2006.
Shiller is one of the leading economists in developing forecasting models for stocks, bonds and real estate, as part of a new branch known as “behavioral economics.”
I met him at his offices at Yale on a beautiful sunlit morning. Here’s what he had to say…
Has the Curse Been Lifted at Yale?
Skousen: For years, Yale University has been cursed with Irving Fisher’s infamous “new era” prediction, “stocks have reached a permanent plateau,” that he made a week before the 1929 crash. [Fisher was a professor of economics at Yale from 1895 to 1935, and was known as the "Oracle on Wall Street."]
But now, judging from the spectacular success of Yale’s $15 billion endowment fund under money manager David Swenson, and your remarkable success in predicting the top of the Nasdaq in 2000 and real estate in 2006, has the curse been lifted?
Shiller: Well, I suppose so!
Skousen: The economics profession is not known for its ability to predict the future. Yet with the success of your forecasting models in your book, Irrational Exuberance, has economics come up with a new way – behavioral economics – to predict cycles, or is it still an art more than a science?
Shiller: Behavioral and financial economics are gaining a lot of momentum and it’s the most exciting thing that’s happening in economics now. But it tends to be in the business school.
My approach in behavioral economics is to look for insights, and not just the data. You must look at the broadest possible picture to see what’s going on. You must use your intuitive faculties, and recognize patterns.
Are Stocks Cheap According to Robert Shiller?
Skousen: In the first edition of Irrational Exuberance, you predicted a possible 10-year bear market in stocks, and here we are in 2006, and while we’ve had a recovery, we still have not returned to 2000 highs for the Dow. In your 2nd edition, you argue that stocks are still overvalued. Why?
Shiller: Because historically stocks are still selling high relative to their earnings. They’ve come down somewhat, because earnings have shot up, but I don’t believe the earnings growth rate is sustainable.
Skousen: Traders say that Wall Street is not a stock market but a market of stocks, and that you can still make good money investing in individual stocks by using sound fundamental and technical analysis. You agree?
Shiller: That’s right. Warren Buffett is an example, and here at Yale, David Swenson. [Swenson manages the Yale pension fund, which has overperformed the market for 20 years.] I don’t want to exaggerate the possibility of making a lot of money in the stock market. It is a competitive business, and most money managers can’t beat the market. But there is a reward to sound, intelligent research.
Skousen: Are you an investor or a money manager? What is your favorite strategy?
Shiller: In addition to being a full-time professor, I’m a businessman-economist and entrepreneur. I recently founded a company called MacroMarkets LLC., which helps create new marketplaces, including Exchange-Traded Funds (ETFs), to expand risk management. We have big plans. We hope that this company will transform the financial markets! Recently we helped create a futures and options market on the Chicago Merc for U.S. residential real estate. It started May 22, and it’s been slow so far, but within a few years, I’m hopeful it will have a substantial impact on the housing market.
Skousen: Funny how many new products come out at the top of the market!
Shiller: Right now, the futures market for U.S. residential properties is predicting 5%-7% lower prices by next year in our 10 cities.
Skousen: Where are you invested right now?
Shiller: I’m invested in foreign stocks, but I’m not sure about the future. I believe in being diversified around the world. I was hot on Russia a few years ago, and that turned out well. But I can’t advise on any stocks right now.
Professor Shiller’s Advice on The “Real” Asset Bubble – Don’t Follow the Herd
Skousen: Have you studied the commodities market, which has been in a full-scale bull market since 2001? Do you agree with Jim Rogers that commodities are a good long-term investment right now?
Shiller: My research shows that investments in commodities have done well over long periods of time. It’s part of our mission at MacroMarkets to develop the markets for investing in commodities.
Skousen: In your book, you make the shocking statement that in real terms, after inflation, real estate hasn’t been that great of an investment, that it barely keeps up with inflation. There have been only two exceptions, after WW2 and the 1998-2006 boom. We’ve seen a slowdown in real estate. Are you predicting an all-out crash or a long bear market? (Are you invested in real estate?)
Shiller: I have to be careful about predicting. I present two scenarios: One is that we live now in a capitalist world where property is king, which is pushing up real estate prices. But in the U.S., real estate prices are softening rapidly and there’s a perception that in the short run they are not going to do well. In the long run, they look pretty solid. The other scenario is that we could go through a Japan-like depression in real estate, because the attitude is the classic “Buy land. They’re not making any more of it.”
Skousen: Keynesians such as Paul Samuelson are famous for being anti-saving, teaching the “paradox of thrift” in textbooks, and arguing that consumption, not saving or capital investment, drives the economy. But you seem to disagree with this standard Keynesian view, and argue that investors should consider “massive” increases in savings. What do you recommend?
Shiller: If you look around the world, you see that higher saving rates correlate with more rapid economic growth. In the long run, we would be growing faster if we increased our savings.
Skousen: You talk about the “inherent instability” of capitalism, but isn’t the instability we see in the market place “exogenous,” coming not from inside the market but from outside forces, i.e., the Federal Reserve’s monetary policies and government intervention?
Shiller: The biggest source of instability is war. But recently, monetary policy by government has been pretty good.
Skousen: Even if they lower rates to 1% as the Fed did in 2004? Wasn’t that reckless and created in part this boom in real estate?
Shiller: You’re exactly right – this has led in part to the asset bubble in real estate. And now there’s a possibility of a bad situation with the current housing market. If it harms confidence, it could cause a worldwide recession. But Ben Bernanke is ready to cut rates when there’s a sign of weakness.
Skousen: One final question. You are a student of economic and financial history. What’s the most important lesson you have learned about human nature when it comes to investing?
Shiller: I can only give you my gut reaction. Successful investing requires inspiration, a special effort of commitment of time and energy, and attention and focus. One of the reasons investors make mistakes is because they don’t pay enough attention. People are capable of extraordinary brilliance, but they don’t often know where to apply it. They end up following the herd and not thinking independently. It’s not just a matter of smarts. It’s a matter of being able to sustain interest.
Skousen: Thank you, Professor Shiller
Dr. Skousen with Robert in his office at Yale
Good trading, AEIOU,
Today’s Investment U Cribsheet
- You can pick up a copy of Robert’s second edition of Irrational Exuberance at Amazon. Also, take a closer look at his latest projects at MacroMarkets.
- 3,944 Winners Today… Of the 6,884 issues listed on the NYSE, the Nasdaq and the Amex, 57% of them were advancers at midday. Leading the charge were a handful of momentum plays: 26 stocks on the Nasdaq were up more than 5%, as were 14 on the NYSE and nine on the Amex. Right now, these seven companies are about to pop, too, as institutional support continues to roll in – to the tune of $15.4 billion.