In his 2000 book, Irrational Exuberance, Robert Shiller, the Nobel Prize winning economist and Yale University professor, warned of high stock prices just before the collapse of the tech bubble. In a revised 2005 edition of the book, Shiller sounded a similar warning about high real estate prices. Essentially, he spotted the last two major asset price bubbles. So naturally, when Shiller speaks (or muses) about the markets, investors listen.
Earlier this month, Shiller penned an article for The New York Times, “Anxiety and Interest Rates: How Uncertainty Is Weighing on Us.” In the article Shiller focuses on how “anxiety and uncertainty are weighing on individuals” and on how this potentially affects asset prices. He points to a recent study that “shows that increased uncertainty about future incomes can indeed push up all asset prices and push down expected returns, even in perfectly efficient markets.”
A couple of weeks after Shiller’s Times article was published, CNBC interviewed him (“Shiller Warns Bond Investors: Beware of ‘Crash!’”); about a week later, he was interviewed by Yahoo Finance (“The Investing Golden Age May Be Over: Robert Shiller”). Both interviews point to what seems to be an underlying theme: “everyone is scared,” and this fear is creating a bit of distortion in how assets are currently being priced.
Shiller is essentially telling investors they may want to stay clear of the long end of the yield curve and that U.S. stocks may be overpriced, especially relative to foreign stocks. What is interesting is not that Shiller might once again be correct in his predictions, but that the route leading him to his conclusions is investors’ angst.
Shiller sees this angst manifested in two primary areas: “fallout from advances in information technology” and the “enormous problem [which] is the psychic cost of growing income inequality” — a psychic cost that is cutting across economic groups and, in particular, is “preoccupying the rich” at the moment.
The latter area represents a perception that Shiller developed at January’s World Economic Forum in Davos. What he heard there, he told CNBC, helped him to “understand that there is not just pessimism about the global economy, but worry.”
The Age of Anxiety
The term “Age of Anxiety” has been used to describe modern times ever since the term was made popular in a 1948 Pulitzer Prize-winning poetry book and poem with that same title. Having just survived two World Wars and facing a protracted Cold War, there was a great deal for the public to be anxious about.
Shiller’s analysis seems to follow this view of modern times (ever-increasing angst), adding to it the dimension of the impact of advancing technologies such as the Internet, ubiquitous computing, robotics and 3-D printers. Due to advances in technology, investors are increasingly concerned about their own personal situation in addition to feeling the generalized public anxiety.
Market Efficiency?
According to Shiller, “markets are really not very efficient, [and] the effect of these varied factors [e.g., anxiety] tends to be amplified through emotional feedback.” Shiller, as is obvious from his solid calls on the two most recent bubbles, believes that asset prices can get out of hand due to the “emotional component of our actions — what John Maynard Keynes, the great British economist, called our ‘animal spirits.’”
Shiller has — and continues to build — a case that the market is not efficient. Just as investors can engage in “irrational exuberance,” they can also react out of fear and park excessive amounts in long-dated government bonds or price up (above their intrinsic value) equities in a market that is perceived as the safest and the most liquid.
Looking Forward
About this time last year, many investors were beginning to test the emerging market waters. After about a six-month run-up, EM retreated. The U.S. finished out significantly ahead of EM — and even ahead of many developed markets, most notably Europe.
This week The Wall Street Journal published a story, “U.S. Money Managers Are Sending Cash Overseas,” stating that because “foreign stocks are less expensive than U.S. stocks, money managers hope they will show bigger gains than their U.S. cousins.” The article goes on to document the asset rotation from domestic to foreign equities that is occurring in 2015 versus 2014.
It will be interesting to see how much momentum begins to build in foreign (both developed and emerging) investing and, if so, whether there is a subsequent retreat to safety as there was in 2014. The question seems to be: Will the Keynesian “animal spirits” continue to drive up the demand for U.S. securities and currency and, thus, only enlarge an existing bubble? This, Shiller believes, is something that many anxious investors should guard against.
