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Speculative Volatility in a Free Society

The final chapter of Robert Shiller’s book Irrational Exuberance has the same title as this blog post and contains a cogent synopsis regarding what some people believe is going on now.  In essence, stock market valuations (especially in the U.S.) have been high for years and most people (investors and advisors alike) didn’t seem to be fussed about it.  Here’s a verbatim passage from the book (page 225 of the 3rd edition), which was written in 2014, when markets were substantially lower than they were when the current down draft began:

 

The high stock market levels did not, as so many imagine, represent the consensus judgment of experts who have carefully weighed the long-term evidence.  The markets have been high because of the combined effect of indifferent thinking by millions of people, very few of whom have felt the need to perform careful research on long-term investment value, and who are motivated substantially by their own emotions, random attentions, and perceptions of conventional wisdom.  Their all-too-human behaviour has been heavily influenced by news media that are interested in attracting viewers or readers, with limited incentive to discipline their viewers or readers with the type of qualitative analysis that might give them a correct impression of fundamental value.

 

My translation of that passage might be as follows:

People make decisions about the value of stocks in general in a vacuum of personal experience and in the context of what others are doing; not in the context of whether stocks are cheap or expensive as compared to historical metrics.  Consequently, “groupthink” causes people to make their personal decisions based on the consensus behaviour of others, who, in turn, are not really looking at valuations, either.  The media exacerbates this behaviour.

 

On the following page, Shiller is even more pointed:

Understanding how social forces cause speculative market moves has been a major theme of this book.  It is so difficult for most of us to figure out which moves are caused by sensible good reasons and expert opinions and which are caused by human imagination and social psychology.  I hope that the argument to this point has made it clear that, as these major markets go, it is often the latter that drives prices.

 

My  translation:

You’re less rational than you think.  Part of why that is, is that you don’t know who or what to believe, so you look for social proof and act in a way that is consistent with the crowd.

 

The fundamentals show that markets were really expensive in late February, 2020.  They seemed to get that way because most people were happy to buy because most people were happy to buy.  Now, that process may be playing out in reverse.  People might be eager to sell because other people are eager to sell… and so valuations come back to more reasonable levels.

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