A Dismal Decade Ahead for Stocks?
TOM PETRUNO 05/28/00
LATIMES.COM -------------------------------------------------------------------------------- Robert Shiller's dream is everyone else's nightmare. Here's what Shiller, a Yale University economist, believes the U.S. stock market should produce in net gains over the next 10 years: nothing.
And that's his best-case scenario.
Say you're a pre-retiree with $300,000 invested in a diversified portfolio of U.S. stocks. You may gladly concede that the market's terrific returns of the last five years--nearly 27%, annualized, in the Standard & Poor's 500 index--were an anomaly.
But you probably still believe that over the next 10 years you'll make some kind of decent return on stocks, maybe 6% or 7% a year.
Wrong, says Shiller. "The market as a whole is likely to go down," he says.
Shiller's dismal vision of the U.S. market's future is contained in his new book, "Irrational Exuberance" (Princeton University Press, 2000), which takes its title from the infamous market reference made by Federal Reserve Chairman Alan Greenspan in 1996.
The timing of the book could hardly have been better for Shiller. The spectacular collapse of technology stocks in recent months has left many investors shell-shocked. With the Fed continuing to tighten credit, worries about the broad market's near-term fate are perhaps the most pronounced since the mid-1990s.
Still, surveys of investors show an abiding long-term faith in the stock market. And why not? For most of the last two decades they have been told by countless market experts that if they can simply hold tight for at least 10 years, they're sure to reap decent returns from stocks.
Not this time, says Shiller. Irrational exuberance over stocks has lifted their prices to absurd levels relative to earnings since the mid-'90s, he says. Likewise, expectations for what stocks can do over the next five to 10 years remain irrationally exuberant, he contends.
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The central element of his argument that the U.S. market is poised for a long period of disappointment rests on historical experience--not surprising for an academic.
Shiller begins his book by chronicling the returns the stock market has produced over 10-year periods since 1881. History demonstrates, he notes, that high returns tend to follow periods of low stock price-to-earnings ratios. The flip side is that periods of high price-to-earnings ratios--such as 1901, 1929, 1966 and 1972--tend to produce poor, or negative, market returns in the following 10 years.
With many stocks now selling at price-to-earnings ratios far above historical averages, the experience of the last century suggests, at a minimum, that investors should be cautious in their expectations for future results, Shiller says--despite the conventional wisdom that a long-term, buy-and-hold strategy is sure to pay off.
"References to history are so simplistic," Shiller, 54, said in an interview last week. "All they think of looking at is average returns. And they don't look at how returns are related to evidence of a bubble. In the periods when the market, looked bubbly it hasn't done well afterwards."
Shiller, of course, is hardly the first man on Earth to point out that stocks now sell at high levels relative to earnings. And that's certainly not enough on which to build a nonfiction bestseller--especially given the fact that the last decade stands in sharp contradiction to previous experience: Stock P/Es were very high in the late 1980s, but returns since then have been stellar nonetheless.
Rather than dwell on valuation issues, most of Shiller's book focuses on the psychology behind market bubbles, and why investors get caught up in them, bidding prices ever higher and thus taking on ever-greater risk of loss.
The media get singled out as a bubble enabler. "The history of speculative bubbles begins roughly with the advent of newspapers," Shiller writes--though that claim, too, is subject to debate.
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In any case, Shiller is most interesting when he delves into why people do what they do. Or perhaps more to his point, why people overdo what they overdo.
He writes: "If one looks back on some of the most significant errors one has made in life, one is likely to find that these often arose from a failure to pay attention to details. One would have responded instantly and changed one's actions had someone repeatedly demanded attention and pointed out certain key facts."
In other words, with regard to the stock market, fundamental financial analysis has been ignored by many investors in this market in favor of mere "momentum" investing: buying what is going up, because it is going up.
Shiller devotes one chapter to herd behavior, and the ease with which humans can be led into such behavior simply because they assume "that all the other people could not be wrong."
In general, Shiller says, market analysts "overemphasize the role of concrete news in these things [market cycles] and underemphasize investor psychology."
Today, he says, many investors understandably believe they know a great deal about the market and why current stock prices can be justified. "I think that was probably an element in other big bull markets. It was an element in the 1920s. [The bull market] had gone on for so long. The thing that was emphasized then was that investors had learned so much," he says.
"It's part of many peoples' self-esteem--'I know about investments, and I've done well.' It creates quite a strong tendency to continue" the same strategies, Shiller says.
All right, let's assume he's right: The market is drastically overpriced. Why will it continue falling? Herd behavior in reverse, for one, Shiller suggests. In addition, he says, we're overdue for economic trouble. "It's very plausible we'll see a recession [soon] and it may even be generated by the market," as people spend less because their stocks are down, he says.
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But here's where Shiller's outlook arguably is far too simplistic: He says the market probably will make no net progress in 10 years. Fine. But in between now and then, what is likely to happen? Say stocks fall 50% from here. If they then rise 100%, the market will only be back to even. But people who were buying at or near the lows will have made good money.
Why, then, would someone who plans to invest regularly over the next 10 years, say, through a 401(k) retirement plan, be scared off by Shiller's views? Even if he's right, there will undoubtedly be opportunities to make money in certain stocks or sectors along the way.
What's more, Shiller concedes, high stock valuations aren't universal. "I think there are good buys in [some] stocks. I'm not disagreeing with that," he says.
And though he has been personally out of the U.S. market since 1998, he concedes that he will be buying if stocks continue to fall.
Pressed by a magazine writer, Shiller says, he recently opined that a Dow industrial average of less than 7,000 would be a good entry point. But he now calls that "a meaningless statement."
"I'm not aspiring to be a guru," says Shiller, who is very pleasant and low-key in person. He feels he can make a broad statement about a poor decade coming for stocks, he says, because history is on his side. But he hastens to add: "I'm not saying it must happen."
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Tom Petruno can be reached by e-mail at tom.petruno at latimes.com