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Shiller: The market is experiencing 'irrational exuberance'

Krystal Hu

The longest bull market in history we are experiencing right now may be unprecedented, but to Robert Shiller, the moment of “irrational exuberance” is coming back.

The renowned Yale economist used the title of his 2000 bestselling book to describe an overheated market on Yahoo Finance on Friday. In 1996, the phrase became well known after then-Federal Reserve Board Chairman Alan Greenspan warned that the stock market might be overvalued.

The burst of the internet bubble ended the previous record bull run from October 1990 to March 2000. Shiller voiced his concern back then, and now takes the bearish case again.

“Are you sensing a little irrational exuberance here?” Yahoo Finance’s Alexis Christoforous asked.

“Well yeah, I think so. I like that term,” Shiller said. “The reason the phrase is so famous, by the way, is not because it’s so eloquent. It’s because… the markets all over the world dropped about 4% when [then Fed chairman Alan] Greenspan said those words. People said, ‘No, this is absurd. If Greenspan uses some colorful language, should the stock markets of the entire world lose?’ It became a good word to describe the kind of craziness that happens in our markets.”

Though Shiller clarified that he was not predicting an imminent market crash.

“The market looks overvalued,” he said. “I’m glad I’m a professor and not a portfolio manager. You can’t predict these things – a boom can go on for longer than you’d ever imagined.”

Robert Shiller speaks at a Wharton conference in New York about the impact of the 2008 financial crisis. (Credit/Shira Yudkoff)

Shiller’s formula for stock valuation, known as the CAPE ratio, which is the price divided by a 10-year earnings average, has been on the rise in the past few years and now stands at 33. It got up to 45 at the height of the 2000 tech bubble.

CAPE, while widely considered a useful metric in asset allocation, doesn’t always work well in the short run. Last year, Shiller suggested investors look into emerging markets, which have better value than U.S. stocks. But the markets have seen a divergence in performance. While the U.S. continues its bull run after small corrections, emerging markets like Turkey, Italy, and China have experienced major meltdowns.

“The CAPE ratio a year ago made me think I want to underweight the U.S. In the last year, it wasn’t a successful strategy,” said Shriller. “But I still believe it in the long run.”

U.S. Stock Markets 1871-Present and CAPE Ratio. (Credit/Robert Shiller)

As populism rises worldwide, the “strong capitalism” in the U.S. encourages winners to win and ignore losers, which may help support the high valuation of big-ticket stocks, Shiller said.

Like many economists, Shiller sees a recession following the historical bull run.

“I think it’s highly likely that we’ll have a recession,” he said, adding that most recessions in history are mild.

The Nobel Prize-winning economist has been trying to understand market behaviors beyond metrics. He said the trigger for the next recession “doesn’t have to be anything concrete.” 

The market pulled back sharply at the beginning of this year, but didn’t tumble into a big correction. That didn’t happen because “people weren’t in the mood for further recession… It’s mainly psychological,” Shiller said.

Krystal Hu covers technology and the economy for Yahoo Finance. Follow her on Twitter.

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