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Robert Shiller: Why Investors Are Comparing COVID-19 to the Great Depression

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Nobel prize-winning economist Robert Shiller believes that the stories we tell ourselves affect our behavior and, if enough people buy into a particular narrative, it affects the behavior of the larger society. 

That’s the case now with a narrative that’s gaining momentum from the COVID-19 pandemic but has long been dormant, namely the narrative of the Great Depression, according to Shiller.

“The focus is on the pandemic now, which took us by complete surprise … Because of its superficial resemblance to the Great Depression, the COVID-19 pandemic sort of becomes the Great Depression if people make a comparison to that. It becomes the event that the narrative of it describes,” said Shiller, who spoke on a webinar sponsored by Natixis. 

He explained that with so many people stuck at home, away from their workplaces and without their usual recreational outlets, they have more time to stew and stress about things. “This pandemic is generating a lot of scary narratives. Some frighten us and will stay with us a long time.”

For example, said Shiller, “I’m not sure how many of us will want to get on an airline in the new future.” But the current narrative may go beyond that, according to Shiller. It can include what’s known as “the affect heuristic,” a mental shortcut used when making automatic decisions, which relies more heavily on emotions than rational thinking, like a gut-level feeling and which may be unrelated to the decision at hand. ”People are reacting with a lot of emotion right now, which kind of surprises me.”

Shiller recalled one study that found that people within 30 miles of an earthquake were also worried about the probability of disaster in the financial markets, which affected their stock market expectations.

As for his view of the market now, Shiller said we may not have seen the bottom yet and annual earnings could be negative for the next year or so.

The U.S. stock market appears to be particularly overvalued compared to all other global stock markets, said Shiller. Its cyclically adjusted price-to-earnings ratio, which measures a stock’s price compared to earnings per share over a 10-year period, is now now 26, higher than the ratio in any other market in the world, and well above its historical average of 17. 

“We don’t know where the animal spirits are going,” said Shiller, referring to the term coined by economist John Maynard Keynes and popularized by Shiller to explain the behavioral component of investor attitudes and actions. “There is a substantial risk of a bad outcome.”

Shiller is also somewhat pessimistic about the residential housing market. The Shiller S&P CoreLogic Home Price indexes that he developed with economist John Campell could start to show declines within a couple of months, said Shiller. 

“We’ve had a good run and I wouldn’t be surprised if home prices started falling a little bit,” said Shiller, noting that prices were already starting to falter before the COVID-19 pandemic hit. “It is an unusual time. Closing dates are being postponed. There could be paucity of closings during this crisis and that may be representative of these chaotic times.”

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