While Prof. Shiller's analysis is highly credible, his suggestions for the individual investor are, in places, difficult to understand. Indeed his discussion of diversification may only be deciphered by his fellow economists. Lay men and women can hardly be expected to know what "...taking short term positions in claims on income aggregates," means. Nor can they regard his advice to invest in markets that do not yet exist as practical guidance. These, however, are minor quibbles. Unlike many market commentators these days, Shiller's underlying social conscience puts him on the side of the little guy. Yet even so, this books is aimed primarily at policymakers who have the power to influence public behavior for the good. The prospect of thousands of retirees living on the margins because they invested too much of their 401(k) money in the stock market is surely one which will compel their attention.
Jim Sanders Annandale, Virginia
Is it different this time? That is the question. Previous reviewers in this space, among them J Weber, were right to suggest reading "Irrational Exuberance" alongside and in contradistinction to "New Era" works, such as Glassman's "Dow 36,000". You be the judge.
But don't prejudge the book on the basis of the rest of J Weber's review. Without wanting to engage in philippics, most of his comments regarding the book are inaccurate, inconsistent, and even self-contradictory. To wit:
To call Shiller "irrational" and an "old-school economist" who "has no understanding of the current market" simply because he disagrees with valuations is simply an ad hominem attack.
To say that Shiller "would only invest in bonds" is inaccurate. In today's context, yes, he would favor bonds over stocks, but not always and in every situation.
Check the facts. Contrary to conventional wisdom, it is not true that history "shows no better place to be than in the stock market". What about from 1929-1954 or from 1968-1982? You can disagree with Schiller's conclusions and still learn alot from his fascinating account of market history.
But you can't argue that the current market is "different" and at the same time invoke history as a proven guide. (And a factually incorrect version of history, at that!)
Moreover, to the extent that Shiller does recommend bonds, he favors TIPS, or inflation indexed bonds. A guaranteed real return of 4% is boring but not too bad over the long run.
Finally, does Mr. Weber know how to add and subtract? Or is basic arithmetic also a casualty of "New Era" accounting? He writes that "Let me see at around 6% a bond will only help my money keep up with inflation". Gee, last time I checked, the CPI was below 3%. 6% - 3% = a real yield of 3%, even if it's not indexed. Let's at least get the math straight.
Why is it so controversial or threatening to note that financial reward involves risk; that stocks, like other assets, can become overpriced; and that as a result, investors can actually lose money?
Having said that I think it is not necessary to be an expert to read and appreciate the book. In fact the book uses a lot of common sense in its presentation of market data and the discussions of the data and the markets.
The most striking thing to me about the book is the description and summary concerning macro trends or cycles in the market. These cycles can extend decades. For example since approximately the late 1800's there have been five or six speculative bull runs to high market P/E values. The exact reason is different for each run up. We have seen run-ups due to the companies involved with railway stocks a century ago, the telephone as an investment tool in the 1920's, and then the new internet companies and trading electronically in the 1990's. The way stocks are bought and are sold and the financial instruments vary with the year or era. But these cycles repeat themselves every decade or two.
In almost every case investors participating in the speculative market spike or bull-run gets carried away and thinks this time, in this era, whether it was the 1920's or the 1990's that investing is now "different". The rules have changed. The high P/E ratios are now the norm. It is a "new era" and the old rules do not apply. Sound all too familiar? But in each and at every peak in the S&P or Dow, reality eventually sinks in, the investors pull back, and the market drops back to its historical average levels. That average level is a P/E ratio for the large cap or S&P 500 companies having an average P/E ratio in the general range of 10 to 20 or 25 maximum.
For some people foolish enough to invest near the market highs, and then who ride the market down have had to wait 20 years to see their stocks return to the same value at which they were purchased. Some stocks and companies do not survive the downturn and the investment vanishes. Now in our time one can only speculate on how many years or decades it will take for the NASDAQ to return to the 5000 to 5500 level.
This is sobering book, and it rates 5 stars for a short but excellent read and education.
Jack in Toronto