Irrational exuberance is a strange phenomenon. That word “irrational” is disturbing. Shiller was writing about stock investing in his book. The suggestion that you get just from reading the title of the book, let alone its words and pages and chapters, is that investors are committing self-harm by giving in to the power of this irrational exuberance phenomenon.
How irrational exuberance works
We are all investors. None of us wants to commit self-harm. So you might think that we would all want to know as much as possible about how this irrational exuberance thing works.
How does irrational exuberance get started?
How long does it take for it to get out of control?
How much of it do we create?
What tools can we use to combat irrational exuberance?
Was there more irrational exuberance in the past or is there more of it today?
How is it that irrational exuberance gets transformed into its opposite, irrational depression?
How aware are most investors of the irrational exuberance present in the price of the stocks they are buying?
How long can irrational exuberance last before a price crash causes it to disappear?
Do you know the answers? I don’t think that most of us do. I have been writing about Robert Shiller’s amazing research for 22 years now, and while I have developed partial answers to most of these questions, there’s still much that I do not fully understand. Sometimes when I am taking a walk a thought will hit me about some aspect of the irrational exuberance phenomenon – “Oh, that’s how it works!”
There’s a lot to learn. And we have not made much progress since Shiller published his Nobel-prize-winning research in 1981 and then published his book on his findings in 2000. It’s certainly not that we do not have a lot of intelligent and industrious people working in this field. Why have we been so slow to develop answers to basic questions that we all very much need to be informed about?
We don’t want to know.
That seems like such a strange thing to say. How could we possibly not want to know what is going on with our retirement money? Of course we want to know!
No, we don’t.
I think that the best way to come to terms with this is to imagine what things were like in the days before Shiller published his research and his book. The phrase “irrational exuberance” did not exist in those days. The phenomenon certainly existed. But not the phrase. I am happy that we now have the phrase. Being able to call out a phenomenon by a name that we all recognize helps us to talk about it. And I believe that the single thing that we most need to do to get a better handle on irrational exuberance is to talk about it more.
The problem of overpriced stocks
In the old days we didn’t have that. But we did have irrational exuberance. We did have overpriced stocks and all the horrors that follow from them. Price crashes. Economic collapses. Failed retirements. Businesses going under. People losing their jobs. Increased political frictions. The entire shebang.
We didn’t have people saying: “We need to do something about this irrational exuberance problem.” But there were hints that overpriced stocks were a problem. When stock prices increased by more than what the economic realities justified, we called it a “bull market.” People love bull markets. But I think it would be fair to say that there’s something more than a little scary suggested by the phraseology. A charging bull is a big and out-of-control animal. That doesn’t sound so great to me. Today I hate the idea of bull markets. I think that a case can be made that even in pre-Shiller days some of us had our doubts and that that’s why the term “bull market” was concocted to refer to these horrible events.
The observation that the market is governed by fear and greed has been around since long before Shiller came on the scene. Saying that bull markets are caused by greed certainly puts them in a bad light. The Buy-and-Holders play it differently. Their claim is that it is economic developments that cause stock price changes. If that were so, insanely high stock prices would always be justified. There would be nothing bullish or greed-related about them. The words that we employed even in the days before the term “irrational exuberance” was available to us suggest that on some level of consciousness we were aware that to permit stock prices to rise too high was an act of self-harm.
So the basic realities have always been the same. Our Get Rich Quick urge (which is rooted in the same place as the Buy-and-Hold urge to rationalize Get Rich Quick thinking with blather about how, no matter how much destruction a bull market causes, our economic system has always been strong enough to recover in time) has always done us harm and we have always suspected that that is the case but we have also never been quite strong enough to prevent it from doing more harm. All that Shiller really did was to show with research that these common-sense intuitions of ours were on the mark, that bull markets really are as dangerous as we have always suspected they were.
We don’t know much about irrational exuberance because we appreciate that coming to understand it will compel us to do away with it and we just don’t want to go there just yet. We enjoy seeing those shiny, false numbers on our portfolio statements and woe to the fellow or gal who tries to talk us out of giving them full credence. Shiller advanced the ball by confirming our suspicions with solid research. The next advance will come when it hits us that, to really bring irrational exuberance to an end, we are going to need to learn a lot more about how it confuses our mental processes.
Rob’s bio is here.
