The S&P 500 is up about 0.75% year to date, while the Dow Jones Industrial Average is down about 1.23% as of mid-Friday. After the magnificent returns of 2013, investors and market experts are naturally asking if the market has topped and a correction is beginning.
Jay Jordan of Jordan Co., for instance, told CNBC on Friday that there could be a 25% market decline later this year, when quantitative easing winds down. And investor Seth Klarman of the Baupost Group told his clients earlier this month that we are “mired in a euphoric environment in which some securities have risen in price beyond all reason, where leverage is returning to rainy markets and asset classes, and where caution seems radical and risk-taking the prudent course.”
Looking at the broader roots of bubbles and busts, Yale economist Robert Shiller says there’s much experts can explain and much they can’t. Nonetheless, in an interview posted Friday by the Wall Street Journal, the Nobel Prize winner tells investors they need to work with professionals rather than do it themselves, given the irrational, unpredictable and volatile nature of stock and real estate markets.
When asked about his view on the causes of market bubbles, Shiller explained that they were a very complex beast: “The story about bubbles was that the markets appear random, but that’s only because markets respond to new information and new information is always unpredictable. It seemed to be almost like a mythology to me.”
But that’s only part of the story, he adds. “The idea that people are so optimizing, so calculating and so ready to update their information, that’s true of maybe a tiny fraction of 1% of people. It’s not going to explain the whole market.”
What can? Human nature is a big factor, he says. We need stimulation, “and people have to have some sense of opportunity and excitement,” Shiller said. “I think profits are an important motivator. In the long run, it’s hard to say that bubbles are really bad.”
The alternative, attempting to “fix them” is no easy task, though it may be worth a shot.
“We could have had a Federal Reserve that tried to lean against that [Internet bubble],” he said. “Ultimately, our policies in economics are somewhat intuitive, and our models are not accurate enough to tell us what the right policy is, so I’m thinking we might have been better off if we tamed these bubbles, but there is no way to be sure.”
Ultimately, investors and other market participants move together, whether they intend to or not. “People think of themselves as such original thinkers when, in fact, most of their thoughts have been transmitted to them from other people,” Shiller stressed. “And there are certain stories in circulation, and they are all in all our minds.”
The stories, he adds, are what resonate with us — not rational information like statistics or theory.
“You can still memorize numbers, of course, but you need stories. For example, the financial markets generate tons of numbers — dividends, prices, etc. — but they don’t mean anything to us,” explained Shiller, who is married to a psychologist. “We need either a story or a theory, but stories come first. Most people don’t really get around to much in the way of theory.”