By Scott Sumner
I distinctly recall that Robert Shiller did not recommend that people buy stocks in 2009. That made me wonder when Robert Shiller did say it was a good time to buy stocks. Stephen Kirchner pointed me to an Alan Reynolds column from March 2010:
On the March 9 anniversary of the stock market implosion a year ago, a front-page story in the Wall Street Journal featured one of the same bears making the same bad argument he made a year ago.
The article, “Worries Rebound on Bull’s Birthday,” was almost entirely devoted to trying to explain a graph by Robert Shiller of Yale, titled “Stocks Still Expensive.” The New York Times ran the same graph on March 15, 2009, to warn us that the ratio of stock prices to earnings “hasn’t fallen as far as the market bottoms of 1932 and 1982.”
By then, reports from Barron’s, Bloomberg and the Wall Street Journal had already suggested that the Dow could fall to 5000 and the S&P 500 to 500. The Journal’s headline on March 9, 2009, was “Dow 5000? There’s a Case for It.”
. . .
Here’s the bottom line: Following Bob Shiller’s “over 20” rule would have kept you out of the stock market every single month from December 1992 to September 2008.
Then Stephen pointed me to a passage from an article written by Robert Shiller in 2003 (p. 38):
In Irrational Exuberance, I gave what I thought was a long list of precipitating
factors for the stock market bubble that began in 1982, accelerated in the late 1990s,
and peaked in early 2000.
The market bubble began in 1982? Even more puzzling, one of the factors listed was the worldwide decline in inflation. But how can a fundamental factor create a bubble? After all, declining inflation sharply lowers the real tax on capital. Capital gains tax cuts are also mentioned. Is it true that “bubbles” can occur when fundamental factors that should push up stock prices, do in fact push up stock prices?
Of course it’s easy to criticize people like Shiller in hindsight. But the Alan Reynolds article is now 4 years old. How does Reynolds’ analysis hold up today? Consider this, from the same article:
Looking at the figures through September of last year (the latest available), the trailing E-P ratio was down to about 1% while the bond yield was closer to 3%. That disconnect is simply because trailing earnings toward the end of a recession are deeply depressed, so that stock prices based on expected recovery look high relative to the previous year’s earnings.
Earnings over the past year are a poor predictor of future earnings, and earnings over the past 10 years are even worse.
When the E-P ratio was unusually high, as in the inflationary 1978-81 period, it means the P-E ratio is very low and bond yields very high. To suggest that the E-P or P-E ratio will invariably return to some long-term norm, as Shiller does, is to suggest that bond yields will likewise return to some long-term norm. But interest rates are determined by variables — such as inflation and real returns on invested capital — that are not simply determined by predictable past trends.
The permabears might make a plausible argument against buying stocks if they argued that a big spike in bond yields was imminent. But that would be inconsistent with their usual forecast of stagnation and deflation. So they’re still peddling the fallacy of “above average” multiples, as they were a year ago.
For the press to still be recycling Robert Shiller’s stale arguments against buying stocks in March 2009, despite what happened since, is a remarkable example of the media’s inclination to favor downbeat theories over any actual good news.
I suppose it wasn’t hard to predict the bounce back of earnings after the recession, although it’s been stronger than forecast. But Reynolds’ claim that P/E ratios and long term bond yields are not necessarily trend reverting now looks quite prescient. Both real and nominal 10 year bond yields have been declining for over 30 years, with real yields falling from over 7% to near zero. Rates are likely to rise modestly in the recovery, but I’d guess they stay lower than the norm of the 20th century. Lots of famous people like Larry Summers are also making this prediction, but Reynolds saw the implications back in 2010.
I met Alan Reynolds at a conference last November and discussed the stock market. He had a smile on his face like the cat that ate the canary. I’m pretty sure he’s been putting his money where his mouth is.
Robert Shiller has the Nobel Prize, and Reynolds is at the Cato Institute. I’m sure Shiller is more respected at elite Ivy League institutions. But I can’t help thinking that Reynolds actually has the better understanding of stock valuations.
Shiller bleg: Can people find me the dates where Shiller recommended people buy stocks? We all know about his famous bubble warning (1996), but when did he tell people to buy into this seemingly endless “bubble?”