Mass Psychology Supports the Pricey Stock Market

First, consider stock prices. They are very high, particularly when using the Cyclically Adjusted Price Earnings ratio, or C.A.P.E., which I defined almost thirty years ago with Prof. John Y. Campbell, who is now at Harvard University. The C.A.P.E. ratio is essentially the price earnings ratio, with annual fluctuations smoothed by averaging. (More precisely, it is the inflation-corrected stock price divided by the lagging ten-year average of real earnings.)

The C.A.P.E. ratio is above 30 today, compared with an average of 16.8 since 1881. It has been above 30 in only two other periods: in 1929, when it reached 33, and between 1997 and 2002, when it soared as high as 44.

The current number is troubling. After the ratio’s peak in 1929, real inflation-corrected stock prices in the United States lost four-fifths of their value by 1932, the biggest crash in the market’s history. And from 2000 to 2003, they lost half of their real value.

So current valuations make the market vulnerable. But it took more than high valuation numbers to precipitate those ugly declines in the past. The other ingredient was mass psychology. For information about what investors thought other investors were thinking, we can go to the newspaper archives.

First, in 1929, before the great October stock market crash, newspapers said prominently and repeatedly that traders were engaging in widespread speculative gambling. In an annual outlook piece on January 1, for example, The New York Times described “fantastic illusions” that were spurring “the most reckless stock market speculation.” The article said it was possible that, before long, “the bubble bursts.”

The notion that investors were laboring under “fantastic illusions” and had bid up prices to unsupportable levels appeared in many places. On the same day, The Atlanta Constitution ran a all-caps banner headline in its financial pages: “STOCK MARKET ACTIVITY AND PRICE FLUCTUATIONS SMASHED ALL RECORDS DURING YEAR JUST CLOSED.”

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The Proquest newspaper database shows an increasing concern that excessive lending to support share purchases was fueling stock speculation, starting in 1927, and peaking in 1929. The database also shows a sudden increase in 1928, and again in 1929, of references to “tulipomania” — the bubble in tulip prices in Amsterdam that crashed in the 1630s. In 1928, the database shows, there was also a sudden burst in the use of the term “speculative orgy” in stock market articles.

Decades later, in the period leading to the dot-com crash that started in March 2000, we saw eerily similar themes in news articles. The term “tulipomania” began to spike again in the newspaper database, for example. And in a 1996 speech, Alan Greenspan raised the specter of “irrational exuberance,”, a term that went viral by 2000 (I made it the title of a book on the markets that I published that year). When dot-com stock prices started to decline in 2000, people were already primed to rethink their assumptions about the wisdom of holding shares in internet companies.


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In early 2000, for example, there was a surge in stories of foolish investors buying anything with “.com” in the company name. Dot-com investments morphed into embarrassing “dot-bombs,” articles said, affecting the self-confidence of stock market investors and plausibly bleeding over to the whole market.

So where are we today?

Mass psychology appears to be in a different, calmer place. Investors do not seem to have the concern they had in 1929 or 2000 that other investors might suddenly sell their holdings and get out of the stock market.

That said, speculation based on excessive lending is a worry, the newspaper database indicates, but less so than in the previous periods. References to tulipomania have been appearing from time to time, but widespread fear that we might already be immersed in a speculative orgy is simply not evident. And while there have been articles this year about the boom in so-called FAANG stocks (Facebook, Amazon, Apple, Netflix and Google), the database indicates that this issue is minimal compared with the attention given in the late 1990s to the dangers of stocks.

In the financial sphere, discussions of bitcoin, the leading so-called cryptocurrency, have gone viral twice, in 2013 and again this year. There may well be a bitcoin bubble, but with a total market value for bitcoin that is still less than $100 billion dollars, potential problems within that world don’t seem to provide investors with sufficient reason to consider bailing out of the vastly larger stock market. And articles about the outlook for the stock market on New Year’s Day in 2017 contained barely a hint of the concerns about speculative mania that were so evident in 1929.

Why people are so calm about the high-priced market is a bit of a mystery. On this, I can only speculate. Perhaps investors have been distracted by the endless flow of news about Donald J. Trump, North Korea, the back-to-back hurricanes and so much else. I don’t really know.

But the result is that while valuations remain very high there just doesn’t seem to be much evidence that many investors in the United States stock market are actively worrying today that other investors are on the verge of selling. Mass opinions may well change, but for now, in the critical psychological dimension, the stock market does not closely resemble the market in the dangerous years of 1929 or 2000.

That doesn’t mean that there is no danger of a crash. But at the moment, the psychological preconditions for a spiraling downturn don’t appear to be in place.

Robert J. Shiller is Sterling Professor of Economics at Yale.

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