The choices that investors make are directed by the Get Rich Quick urge residing within them. It is that Get Rich Quick urge that makes the irrational exuberance examined in Shiller’s famous book possible.
Isn’t that so? Isn’t it strange that there is a book about stock investing with the title “Irrational Exuberance”? People invest in stocks to finance their retirements. You would think that they would be super rational about the subject. But that’s not what Shiller’s Nobel-prize-winning research shows. His research shows that at times like today (with the CAPE value in the 30s), investors are super irrational. Such a strange business. What gives?
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In part it’s just that we all like the idea of getting something for nothing. When we push stock prices up above the level justified by the economic realities, that’s what we get. Irrational exuberance -- price gains beyond those justified by economic realities -- is money for nothing. Our common sense tells us that there must be a catch. But we tell our common sense to quiet down. We like irrational exuberance, we like something for nothing.
But that’s only the beginning. If irrational exuberance were something that inflated stock prices by 10 percent or so from time to time, it wouldn’t be a big deal. Stock prices would eventually fall by that 10 percent and things would be back to normal. No biggie.
The Manifestation Of The Get Rich Quick Urge
But that of course is not how it works. Today’s CAPE level is 36, more than two times the fair-value CAPE level of 16. If stock prices were to return to fair-value levels, half of our stock portfolio would be wiped out. Hundreds of thousands of businesses would fail because consumer spending would contract. Millions of people would be thrown out of work. That’s a lot of irrational exuberance. That’s a mountain of Get Rich Quick thinking manifesting itself in our lives.
Why do things get so carried away? It’s because, once irrational exuberance starts growing, there is no brake on it. If we took Shiller’s work seriously, we would calculate how much harm was being done by the irrational exuberance as it was accumulating and we would pull back on the Get Rich Quick thinking. We would engage in market timing to get prices back to where they belonged.
We don’t do it. A few of us make noises from time to time suggesting it might be a good idea. We tune them out. Bull markets sometimes slow down for a time. We put them on pause for a few months or for a few years. But they do not come to a complete stop until there is a price crash. There doesn’t seem to be any other way to rein in the emotional impulses that cause roaring bull markets but to cause great pain to millions of people.
It’s a defect in our psychological make-up that requires that things play out that way. We have a natural inclination to want prices to go up for no good reason and that gets the ball rolling. But the far bigger factor is our strong reluctance to come to terms with the damage that we are doing once things start to get carried away. It is not just that our exuberance about high stock prices is irrational. It is irrational in a determined, willful, heedless-of-the-consequences way. Once a bull market has continued long enough, we find ourselves pushing prices up to levels that would have shocked us a few years earlier.
The psychological block is the shame we feel over what we have done. The damage done by a bull market is small in its early years. So the shame felt over it is limited. But as prices rise higher and the risk attached to them grows greater, the shame we feel over our irrational behavior grows stronger. When a bull market has been in place for a long time (this one has been in place for a longer time than any earlier bull market in U.S. stock market history), the shame grows so strong that discussion of the dangers of bull markets becomes taboo. Irrational exuberance is fun in its early days, In its later days, it becomes something that we cannot bear to look at closely.
All of this sounds depressing. It sounds as if we are going to keep committing the same mistakes over and over again, to continue causing the same pain because we humans are just not capable of doing better. I don’t think that’s right. I think we are capable of doing better. I think that Shiller’s book shows the part forward. Shiller was awarded a Nobel prize for a good reason. His stuff is revolutionary stuff. No one has ever before described how the stock market works in the way that he has. If his ideas break through to the public consciousness (I believe that this will happen in the days following the next price crash), the entire ballgame will be changed in a fundamental way.
The turning point will be the day when we learn how to face our shame over tolerating even a small amount of irrational exuberance. If price crashes and the economic crises that follow from them are bad, then all irrational exuberance is bad, even small amounts that cause stock prices to be off by only 10 percent or 20 percent. If all irrational exuberance is bad, then one of the top priorities of stock investors should be engaging in market timing, the only way known to combat irrational exuberance.
“Time” is a four-letter word for most of today’s stock investors. That’s what needs to change. We need to come to understand how important it is to get prices right, which means that we need to come to understand the far-reaching benefits of a healthy attitude toward market timing. Which means that we need to get over the shame that we feel today whenever the subject of irrational exuberance and market timing comes up in conversations.
Rob’s bio is here.