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Third Edition of Irrational Exuberance

Taking a Closer Look at Bond and Equity Values

Stuart Quinn    |    Housing Policy

In his Two Pillars of Asset Pricing speech, economist Eugene Fama said that most policy statements containing the term ‘bubble’ usually refer to "an irrational strong price increase that implies a predictable strong decline."1 This notion of predictability, or the ‘pop’ of bubbles, has been questioned by others, including Fama, with economists such as Princeton professor Alan Blinder likening the price drop to the suspension felt by Wile E. Coyote after he has been deceived by the Road Runner and run off a cliff—the inevitable is known, but the realization of being unsupported and the exact timing of sharp readjustment is harder to predict.2

In the third edition of the landmark book Irrational Exuberance, 2013 Nobel Laureate in Science of Economics, Dr. Robert Shiller, elaborates on his extensive work covering speculative bubbles. He explains this using three primary cycles: the Millenium Boom (1982-2000), the extensively documented housing bubble or the ‘Ownership Society Boom’ and the current state of the equity and bond markets from 2009 to present.

Shiller expands on a host of metrics and surveys designed to better understand if a bubble is occurring in the equity and bond markets. Using the cyclically adjusted price to earnings ratio (CAPE) developed by Shiller and University of Harvard professor John Campbell, Shiller attempts to measure how expensive the market is relative to an objective measure of the ability of corporations to earn profits as adjusted over time.3 As of June 2015, the CAPE metric resided at nearly 27 (26.73), which is high by historical standards. The only other times it has been 27 or higher were in 1929, 2000 and 2007 (see Figure 1). Despite this and other measures, Shiller announces there are bubble elements, but not necessarily what he would term a social epidemic with extravagant expectations. On July 27, CoreLogic has the opportunity to host Laureate Shiller at the annual CoreLogic RiskSummit and delve deeper into the underlying concepts, precipitating factors and risk attributes associated with three of the largest markets: real estate, bonds and equities.

As long-term interest rates remain low given historical norms, there will be dialogue about how this plays a role in current asset valuations and how this has perhaps morphed the traditional investment behavior we have seen across these different asset classes.

Dr. Shiller will appear with other notable economists at RiskSummit 2015.

[1] Fama, Two Pillars of Asset Pricing, 2013, p. 374
[2] Blinder, After the Music Stopped, 2013, p. 39
[3] CAPE: real (inflation corrected) S&P Composite Index divided by the ten-year moving average of real earnings on the index. The ten year average attempts to smooth out temporary spikes and declines seen within a normal business cycle.

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