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Irrational Exuberance
from the Is-technology-driving-economic-markets-nuts? dept.
The conventional wisdom has it that technology is only good news for the American economy: Productivity and profits are rising. Investors, newly empowered by digitally-acquired information and transactional software tools, are enthusiastically pumping capital into companies they think will grow in value. And lots of these investors believe that the likeliest stocks to increase in value are technology companies. The tide of easily-available information allows them to feel well-informed and well-prepared, and reduces their fears of overpaying.
"Because knowledge once gained is irreversible," Federal Reserve Chairman Alan Greenspan told economists in a recent speech, "so too are the lowered risk premiums."
But in Irrational Exuberance, published by Princeton University Press, Shiller argues that stock markets are being driven by psychology and emotion -- in particular by an "irrational exuberance" fueled not by information but by impulse, herd behavior, dinner party chatter, intuition, media hype, fear of being cut out -- everything, in fact, but reason. Thus, he explains, there is a growing unease about the alleged, techno-driven Long Boom underway in American markets.
By historical standards, Shiller says, the U.S. stock market has rocketed to astonishing high levels. But if the history of high market valuations is any guide, the public may be profoundly disappointed with the market performance in the years to come.
This isn't just an economic issue for profit-hungry stock trawlers. How the market is valued affects the economic, political and social policies questions of society at large (and affects technology industries in particular). If a stock's value is exaggerated or climbs artificially high, then the country may invest too much money in business start-ups and too little in infrastructure, research, education, and other forms of "human capital." Thus if people lose faith in the market's future, they may associate that disappointment with technology.
The explosive growth of the Net and Web in the second half of the 90's has affected how Americans view the economy in general, and markets in particular, writes Shiller.
The Mosaic browser first became available to the public in l994. That date more or less marks the beginning of the Web, but only a few people had access to it. Large numbers of Web users didn't appear until l997, marking the very same years when the NASDAQ stock price index took off, tripling to the beginning of 2000, and price-ratio earnings entered unprecedently high territory. Net technology, writes Shiller, is unusual because it's a source of entertainment and preoccupation for so many people. It conveys, he argues, the sense of a changed future, of mastery of the world, which makes it plausible for people to assume that it also had profound economic importance.
"But we may question what impact the Internet and the computer revolution should have on the valuation of existing corporations," writes Shiller. "New technology will always have an impact on the market, but should it really raise the value of existing companies, given that those existing companies do not have a monopoly on the new technology?" The notion that existing companies will benefit from the Net revolution is belied, he argues, by the stories of E*Trade.com, Amazon.com and other upstarts, who didn't even exist a few years ago. What matters for a stock market boom isn't the reality of the Internet, but rather the "public impression" that the revolution creates.
This is a risky way to approach markets, he argues.
It also distorts the way people -- especially Americans -- view technology. The fixation on technology as force for wealth and economic growth is yet another distraction from the growing list of critical technological issues -- corporatization of technology, genetics, nano-technology, bio-tech, AI, supercomputing -- and other issues and concerns that are rarely discussed in mainstream media or political forums.
Shiller cautions that we might also become complacent in maintaining savings, improving the Social Security system or providing other social safety nets. We might also lose the opportunity to use our improving financial status to create slutions to real risks many Americans face -- to their homes, schools, cities and livelihoods.
This irrational exuberance (and its resulting complacency) is not only driven by the national obsession with computing technology, but affects the future of technology in a particularly direct way. The Internet, for all the hype, is still in primitive, nascent form. Some of the new technologies computing may spawn -- genetic research, nano-technology, bio-tech, supercomputing, AI -- will require vast amounts of capital that only a healthy stock market environment can generate. The collapse of this market, or doubts that it will grow and prosper, could have a devastating impact on the development of these new technologies.
Shiller warns in his book that a long boom may not be in the cards. By l999, he writes, the Dow Jones industrial average had more than tripled in five years. But personal income and gross domestic product each rose less than 30%, and almost half that increase was due to inflation. Corporate profits rose less than 30%. The size of the stock market's gains, he therefore cautions, may be unwarranted and unlikely to persist.
The mainstream media, as usual, has been far from helpful, lurching from one hysteria -- sex and thievery online -- to another -- dot.com investment hype. When it comes to grasping the impact of technology on society, the public has from the first stirrings of the Internet, pretty much been left on its own. One of the conclusions it has reached is that anybody with a computer and a modem can be a savvy, well-informed and ultimately profitable investor. This idea is at the core of the "irrational exuberance" Shiller is writing about. It it's true, we're in for many good and prosperous years, at least in terms of the economy. If it's not, and this feeling is illusory ...
Contemporary technology has, without a doubt, challenged historic ideas of how the economy works. Computing in particular is not only changing commerce, but revolutionizing access to markets by individual market investors, thus changing the markets themselves. The atmosphere surrounding technology is super-heated. It seems that half the country is buying tech stocks, the other feeling as if it should and could. E-trading has been in part responsible for the explosive growth in Americans use of the Net in the past two years, and also in the expectations of many Americans that technology is synonymous with growth and wealth.
Most of the current generation of technology leaders and workers has never really known recession, depression, or even much in the way of serious reversal. Unless people begin to invest in diverse and different ways, that could change, says Shiller.
He pleads for the expansion of the number and variety of securities and markets for them, to allow people to protect themselves against major economic risks. He favors new "macro-markets" that would include markets for long-term claims on national incomes for the world's major countries, and for truly diversified global portfolios, instead of limiting investors to securities that are claims on corporate profits, as is the case now.
"A doctor in Des Moines could take a short position in medical incomes and a short position in expensive Des Moines single-family homes," writes Shiller, "therefore effectively insuring against risks to both sustenance and shelter. At the same time, the doctor could buy securities linked to incomes around the world and to real estate around the world." These macro-markets would be bigger than current markets and far more diverse in the risks they present to people.
Irrational exuberance seems the right term for the atmosphere surrounding tech-driven markets. Millions of Americans are now using the Net to break open access to markets, even as they've driven prices up, they have clearly exposed themselves and their futures to risk.
It's almost impossible to pick up a newspaper or magazine without seeing more hype about the techno-boom and the wealth it's generating. This is dangerous, Shiller warns; it's a serious mistake for political and business leaders to acquiesce in such high stock valuations. It thus follows that it's not a good idea for the rest of us either.
"All of our plans for the future, as individuals and as a society, hinge on our perceived wealth," he warns, "and those plans can be thrown into disarray if much of that wealth evaporates tomorrow."
If you want, you can purchase this book at fatbrain.com.
I've been saying this for years... (Score:3)
Ask yourself: if a heavy-equipment manufacturer had revenue, earnings, and growth identical to Yahoo!, would you pay $150 a share for it?
Another problem that isn't mentioned in the text (though it may be in the book) is that there is way too much money in the form of pension funds and other public and private "forced" investment. This causes a localized inflation in equities markets as too many dollars chase too few viable investments. "Why would you buy Amazon???" "Gotta buy something..."
So here it is, on the record and read-only: my target for the NASDAQ index bottom, whenever it's finally reached, is...2000. And I hope it kills all the idiot investors who seem attracted preferentially to unprofitable companies.
Please, don't sue me if you use this for advice. In that case, you're an idiot as I have no qualifications.
Re:The irrationality of "the next big crash" omens (Score:3)
There is little cause to worry.
"ATTENTION, AMERICA! EVERYTHING IS JUST FINE! PLEASE STOP CARING AND START WATCHING HOURS UPON HOURS OF WWF WRESTLING! YOUR LEADERS WILL TAKE CARE OF YOU!"
There *is* cause to worry, in fact there's a lot of them. We'll start with the easiest, which is the fact that the majority of the "safeguards", that you're referencing such as the Glass-Steagall Act of 1934 that made sure that banks and insurance companies stayed out of other markets, are being repealed left and right.
I'm telling you, the people in power are going absolutely apeshit this time around, and if there is a crash, this time it's going to be *big*. And it's not going to have anything to do with economics, I would guess, since the ruling economic institutions have found themselves to be able to keep things seemingly good no matter what happens...
No, if there's a crash, it will most likely be environmentally based. Think about the fact that we can eat over 30,000 different types of fruits and vegetables, but yet we focus on 30 specific types/strains? What about the fact that this group that we do rely on is becoming increasingly genetically modified, pesticide-ridden, irradiated, etc?
What about the fact that the World Water Forum has concluded that the next World War will probably be fought over access to clean water? What about the fact that, despite this, they're looking to privatize water supplies (rivers, lakes, oceans, etc) anyways?
The truth is that people and the environment are not governed by the rules of "the market", and either we can help destroy this economy of ours, or some horrid environmental issue will do it for us.
Also, look here [salon.com] for a perspective on the corporate state.
For how long are we going to watch people like Donald Fischer (The Gap CEO) exploit sweatshop labor and destroy old growth forests? How long can we let Monsanto have it's way with nature? How long will we allow the corporate press to wax ecstatic about an economy that's completely fake?
How long will we buy their bullshit before we turn around, find ourselves a big stick, and clock these bastards upside the head?
As for me? I hope for the land of do-as-you-please.
Michael Chisari
mchisari@usa.net
hold the front page (Score:3)
http://finance.yahoo.com/q?s=^IXIC&d=1y [yahoo.com] NASDAQ: one year chart
It certainly looks like a big correction could come any day now. Oh yes.
Camaron de la Isla [flamenco-world.com] 'When I sing with pleasure, my
Makes sense (Score:3)
I believe that this is a result of what Shiller refers to as herd mentality. The same phenomenon that has led to the insane IPOs is going to bring the market down. At some point some number of people are all going to bail on tech stocks at approximately the same time. The 'herd' who are trading from their home computer will nearly instantly begin selling their stocks.
We've seen this happen already a few times in the last six months to differing degrees. I find it very likely that the biggest 'crash' is in the imminent future.
Hardly new.. (Score:3)
Look at the South Sea Bubble of 250 years ago for yet another example that
a) Stockbrokers are like sheep
b) people are greedy
The market _relies_ on the sheep and herd mentality to get by. Economics is a psuedo-science that postulates theories that cannot be used. The Best Economics theory is by an ex-Head of the London School of Economics after the disasterous use of an economic theory by Margret Thatchers goverment... "Any economic theory that is used to determine policy shall cease to become valid". In other words folks it doesn't work at all.
I laugh out loud when I hear of yet another wonder theory in the field of economics, remember Hedge Funds ? The great way to make a profit guarenteed.... didn't work did it ?
The tech sector is a classic example of economists and brokers attempting to proscribe generalities to a broad sector. Most "reports" place Sun, Microsoft, IBM and Oracle in the same bag as Boo.com, etrade.com and various other
However when the market plunges expect them to take a hit. And when they do... buy them. Parts of the tech sector are over-valued, but not ALL of the tech sector is over-valued.
I just mentioned this yesterday to a friend. (Score:3)
Duh. Most people realized this in 1999 and if they didn't then they would have after the dot com massacre of a few weeks ago. All it takes is one question to make people realize that the market is no longer fueled by hard facts but emotions and rumor.
Q: Why does the fact that MSFT is being split up mean that the shares of Yahoo, Oracle, Red Hat, Amazon, Sun etc. should all fall 10 to 25 per cent?
A: There is no logical reason that can be backed up by financial data or hard facts. But there are several emotional reasons why this could occur, chief of which is "If MSFT shares are falling then the shares of the stock I own will fall as well, I better sell.".
Counterpoint (Score:3)
FUD, FUD, FUD. Cisco (CSCO [yahoo.com]) is America's most valuable company and can be considered more successful and monopolistic than MSFT in every sense of the word. MSFT was punished not for being to successful or even for being a monopoly but for using it's success unfairly to damage competitors. Cisco (as well as Intel after making deals with the DOJ) is more successful than MSFT and is a technology company, yet it is not being harassed by the DOJ because "crush the competition by any means necessary" is not their guiding principle of operation.
The coming crash? (Score:3)
1. Buying stock on margin call's of 50% is now becoming common again. The last time margin calls were this high was right before the '29 crash.
2. The number of individual investors has gone way up over the past 10 years, thanks in large part to internet and day trading. Again, this is what happened right before '29.
My biggest fear about the stock market is not whether internet/technology stocks will go up or down, it's what happens to Joe Investor when they do. People who are not seasoned investors are now putting a significant portion of their money into stocks, internet or otherwise. What happens if tech stocks start to tank across the board? Old pro's will recognize this as a perhaps inevitable market correction. They may sell, or they may wait it out. Likely the experienced trader can afford to take a little hit to the bottom line, so they don't panic.
Joe Ameritrade, on the otherhand, see's all his lovely $80/share stocks suddenly hovering around $20/share. Perhaps he panics, figures he'd better sell everything while he can, and starts to drive the price even lower. A major hit to tech stocks would start to affect other industries as well, dragging the entire market down.
It's not hard for me to belive that a major, sustained downturn of internet/technology stocks would have a long-term, adverse affect on the market and our economy in general. We may not be talking 10 year depression, 30% unemployment, 30's style crises here, but for all of us dependent on information technology for jobs, times might be rough indeed. Brother, can you spare some bandwidth? Will code for food?
Individually yes collectively no (Score:3)
I think it was cringely who pointed out that a simple analysis suggests it is undervalued. Technology and internet sales should in the future account for a sizeable percent of all transactions. Therefore comparing against the total amount of sales in the US the total valuation of internet stocks isn't very large.
The question at hand is then will the internet market be filled by a few big companies or many many small stores. If the former then the valuation for amazon.com and similar stores is not to high as they will probably control all of the internet market (the internet equivalent of GE or something). If on the other hand the low cost of entry into the market opens them up to little stores then they are tremendously overvalued.
Fortunatly for them it does appear that the internet will come to be dominated by a few big companies in each area. Unlike conventional stores there are no underserved areas to strat a new company in. If I start a new brick and mortar store I automatically get a certain customer base of those people closer to my store than to the other. People may be dribing around and happen to stop in. The web on the other hand has no such features. If I happen to see another book store online it is no more trouble to click the bookmark for amazon then to enter this other store.
Furthermore much more than conventional stores people wish to shop the same places online as there friends do. This is augmented by the efforts of these online stores to set up programs benifiting those whose friends are also members (gift lists etc..).
As people seem to neglect price differences under a dollar or so the competition on the internet seems an unlikely force to draw people to seperate vendors. In fact the major vendors have a size advantage which is not compensated for by any sort of local advantage as every web vendor is an international seller.
In truth it wouldn't be that surprising if one gnereal purpose retailer ended up serving 90% of the internet orders. As such the high internet prices can be viewed as a bet that this vendor is going to become the powerhouse or at least one of them.
Two quick thoughts. (Score:4)
I will be the first to argue that there is a speculative bubble going on over the Internet. And I strongly suspect we're going to see a fairly large (20%? 30%?) correction on Nasdaq when that bubble pops.
However, what most people who have been predicting a popping Internet bubble have forgotten is that a second thing is fueling the increase of the Dow Jones: lowered capital gains taxes has made it cheaper to invest in stocks.
When capital gains were high, it was expensive to invest in stocks. Specifically, it was expensive to withdraw your money from a long-term investment and transfer it into another investment, or to withdraw the money and pocket it. In addition to income taxes, you were often hit up with a 30-35% capital gains. That means that if you were seeing a 10% rate of return, that the real rate of return was really 7%--better to put the money in a savings account where the return was maybe a point or two less, but guarenteed by banking insurance laws.
When capital gains dropped, it made it more attractive to put money into stocks: now, the point spread between an insured savings account and a portfolio was much greater, and made the risk of losing your principle worth it--of course assuming a diversified portfolio.
So when long term capital gains were cut in half, more people started putting their money into stocks. This made money on Wall Street "cheap", and increased the average P/E ratio of companies on the Dow Jones. And that drove the average up.
Most people argued for a cut in capital gains because they wanted to see more money invested long term in our economy. What people forgot (and forget even now) is that when you do this, you don't grow the overall economy overnight--instead, you make it easier for companies to get capital. Hense, the increase in the Dow Jones.
This is not "irrational exuberance"; this is a direct result of making it easier for established companies to raise capital in a capital market where money is cheaper to obtain. Expect this to collapse only if congress jacks capital gains up to 35%.
Two: about technology "irrationality": we're already starting to see people figure this one out. A meeting I had with a Venture Capitalist (to help someone I know raise capital for his software development company) told me that he thought that many of the overhyped Internet stocks were incredibly silly, and he refuses to invest in new internet resalers.
His rational was this: before the Internet, mail-order companies were fearcely competitive. The supply chain (that is, the chain of people between the manufacturer and the end consumer) in the United States was one of the most efficient in the world--in part because of a lack of entrenched monopolistic players or government regulations which causes supply chains in countries such as Japan to be enormously inefficient. And before the Internet took off, the supply chain was being made even more efficient--as were manufacturers--by such things as increased delivery efficiencies by players such as UPS or FedEx, as well as better stock management, stock prediction software, and "just in time" manufacturing and delivery of goods.
The only two "inefficiencies" that existed in this supply chain is the 40%-60% markup at the retail outlet (which is required to maintain the store front as well as advertising), and for mail-order catalogs, the 15%-20% markup necessary to pay for advertising costs. And these aren't really inefficiencies: advertising costs are necessary as people who don't know about your product won't find it.
So at best, the only places where you can squeeze cost savings out of the supply chain are in areas where competition amongst the various supply chain venders and other folks are really really good at it.
At best, by computerizing the whole supply chain and fronting it with a web site to reduce advertising costs, the most you can hope to squeeze out of the process is perhaps one or two percent--a margin which makes the margins used by grocery stores seem absolutely outrageous.
And many Internet business plans called for making a living on that 1 or 2%, including paying for extremely technically skilled experts, and paying for all this supply chain infrastructure that they said they were better at performing than people who have been doing it for 50 years.
Already a number of Internet companies are backing off trying to make a living on creating more efficiencies, and emphasizing selection over price. For example, Amazon.com is really emphasizing the whole "best selection on earth" logo--in part because while their prices are good, they're not great: they do not factor in shipping and delivery costs which are traditionally part of the costs factored into buying books from a bookstore.
How this will help the up and comming B2B web sites is beyond me--as these people are in essence saying they can make a living supplying what was originally the job of an MIS department over the web more efficiently, and skim the price differential.
Yeah, right.
This is what I'd call "irrational exhuberance."
Economic Forcasting 204 (Score:4)
Personally, I look on the possibility of a serious correction in the markets as a buying opportunity. The secret is to find the companies that are fundamentally strong. Their stock prices will take a hit too. But they will come back, faster and stronger than the rest. If you are worried about whether good companies will be able to get funding, go find them and supply it yourself. Buy their stock. It could make both you and them rich and successful.
I don't really understand... (Score:5)
I'm also concerned about a lot of other parallels with the late 1920's -- everyone's into playing the market, people talking about fundamental transformations of the economy, seemingly very low inflation in the price of material goods (as opposed to assets), increasing inequality, and such.
But then Shiller recommends more of the same medicine -- expansion of the financial markets, "to allow people to protect themselves against major economic risks." In an irrational boom, this would only add fuel to the fire. Yes, the doctor in Des Moines could take a short position in medical incomes and in Des Moines real estate (which amounts to shorting against the box, a conservative way of locking in a profit). But is that what the doctor would really do? I doubt it.
More likely, one of two things would happen:
1) The doctor would go long on both positions, as a way of leveraging his income.
2) Even if he shorted, the price of these securities would continue to rise in the short term, squeezing him (forcing him to cover his short position by buying the securities at a loss).
The net effect is that our hypothetical doctor is more exposed, not less exposed, to risk.
(There's also the little matter of what underlying assets these securities really represent. If they're merely trading instruments, with nothing backing them, then they're simply a form of betting and aren't hedging anything at all. Traditional options actually give the holder an option to purchase or sell a particular asset. Common stocks, while the connection is a bit more tenuous, do represent the ability of the issuing corporation to pay dividends, buy back its own stock, and otherwise benefit the shareholder. For this kind of scheme to work, a pool of doctors would have to pledge some fraction of their future income as ultimate payment on the security. That implies that they expect that income to be less than the price they write the option at. Uh huh.)
We've seen the trouble that even sophisticated corporations specializing in financial services have gotten themselves into with derivative securities. Other companies have gotten themselves into trouble because they think they're hedging against some risk, where in fact they're doing nothing of the sort. And Shiller expects individuals to do better? If people systematically make mistakes -- and part of "irrational exuberance" is that people are consistently taking an overly optimistic view -- then there's a lot of potential for, shall we say, adverse consequences when things turn. Positive feedback (leveraging is a way of accomplishing this) is incredibly dangerous. It's even worse if people think they're hedging (applying negative feedback to their portfolios) when they're doing nothing of the sort.
One of the things that fueled the crash in 1929 (whether it fueled the depression is another matter, but it's hard to see how it helped) was margin calls that led to what might be called a "death spiral". As the market dropped, people who bought stock on margin (with loans from their brokers) faced "margin calls" -- they had to pony up more cash because the value of the security was insufficient collateral for the loan. If they couldn't come up with the cash, they had to sell in order to raise the cash. The selling, of course, only drove prices down further, closing the feedback loop. Bad news. If the amount of the loans were less as a fraction of the value of the securities bought, there would be less risk of this because the market would have to fall further to trigger the margin calls that fueled the rout.
I think that Shiller himself is a victim of the exact irrational exuberance he claims to be concerned about. He's right to be concerned about the insanity of the high tech (particularly the internet) sector right now, but I'm afraid that he simply wants to drain the craziness into everything else. Allowing people to leverage their future income is potentially disastrous. What happens if their future income is insufficient to cover their bet? Or, for the bear, if their counterparty can't cover? Then even the supposed hedge turns out worthless, and even the bear loses. That, I think, is even more dangerous than the current high tech boom.
Call me a fuddy-duddy (at 36!), but I want to stay WELL away from that kind of nonsense.