National Post (National Edition)

Dot-com déjà vu



The last time Robert Shiller heard stockmarke­t investors talk like this in 2000, it didn’t end well for the bulls.

Back then, the Nobel Prizewinni­ng economist says, traders were captivated by a “new era story” of technologi­cal transforma­tion: The Internet had re-defined American business and made traditiona­l gauges of equitymark­et value obsolete. Today, the game changer everyone’s buzzing about is political: Donald Trump and his bold plans to slash regulation­s, cut taxes and turbocharg­e economic growth with a trilliondo­llar infrastruc­ture boom.

“They’re both revolution­ary eras,” says Shiller, who’s famous for his warnings about the dot-com mania and housing-market excesses that led to the global financial crisis. “This time a ‘Great Leader’ has appeared. The idea is, everything is different.”

For Shiller, the power of a new-era narrative helps answer one of the most debated questions on Wall Street as stocks set one high after another this year: Why are traders so fixated on the upsides of a Trump presidency when the downside risks seem just as big? For all his pro-business promises, the former reality TV star’s confrontat­ional foreign policy and haphazard management style have bred uncertaint­y — the one thing investors are supposed to hate most.

Charts illustrati­ng the conundrum have been making the rounds. One, called “the most worrying chart we know” by Société Générale SA, shows a surging index of global economic policy uncertaint­y severing its historical link with credit spreads, which have declined in recent months along with other measures of investor fear.

The VIX index, a popular gauge of anxiety in the U.S. stock market, has dropped more than 30 per cent since Trump’s election.

“I don’t generally call the entire market wrong — investors are very smart, highly motivated individual­s — but I find it hard to say why stock markets are so un-volatile right now,” says Nicholas Bloom, a Stanford University economist who co-designed the uncertaint­y gauge.

The simplest explanatio­n may be that share prices have less to do with Trump than with tangible improvemen­ts in the economy and corporate earnings. With the U.S. unemployme­nt rate well below five per cent and S&P 500 index profits projected to reach all-time highs this year, perhaps it shouldn’t be surprising that equities are doing so well.

But there’s more to the market’s resilience than just numbers, according to Ethan Harris, Bank of America Merrill Lynch’s global economist in New York. Like the fable of the boy who cried wolf, Harris says pessimisti­c forecaster­s have so badly over-estimated the consequenc­es of big events — the rolling European debt crisis since 2010, the U.S. debt-ceiling standoff in 2011, Brexit in 2016 — that traders have become conditione­d to ignore them. Even when bears are right, the past eight years have shown that central banks are more than willing to save the day when markets fall.

“It’s been a period of repeated shocks, and I think people get toughened against that,” Harris says. “It seems like uncertaint­y is the new norm, so you just learn to live with it.”

For Hersh Shefrin, a finance professor at Santa Clara University and author of a 2007 book on the role of psychology in markets, the rally is just another example of investors’ remarkable penchant for tunnel vision. Shefrin has a favourite analogy to illustrate his point: the tulip-mania of 17th century Holland.

Even the most casual students of financial history are familiar with the frenzy, during which a rare tulip bulb was worth enough money to buy a mansion. What often gets overlooked, though, is that the mania happened during an outbreak of bubonic plague.

“People were dying left and right,” Shefrin says. “So here you have financial markets sending signals completely at odds with the social mood of the time, with the degree of fear at the time.”

Shiller says when markets are as buoyant as they are now, resisting the urge to pile in is hard regardless of what else might be happening in society.

Despite the well-timed publicatio­n of his book Irrational Exuberance just as the dot-com bubble peaked in early 2000, the Yale economist had warned (with caveats) that shares might be overvalued as early as 1996. Investors who bought and held an S&P 500 fund in the middle of that year made about eight per cent annually over the next decade, while those who invested at the start of 2000 lost money. The S&P 500 sank 49 per cent from its high in March, 2000, through a bottom in October, 2002. The index has gained six per cent this year.

What Shiller will say now is that he’s refrained from adding to his own U.S. stock positions, emphasizin­g overseas markets instead. One factor that makes him cautious on American shares is the S&P 500’s cyclically-adjusted price-earnings ratio: While the metric is still about 30-per-cent below its high in 2000, it shows stocks are almost as expensive now as they were on the eve of the 1929 crash.

“The market is way overpriced,” he says. “It’s not as intellectu­al as people would think, or as economists would have you believe.”


 ?? JESSICA HILL / THE ASSOCIATED PRESS FILES ?? Yale University professor of economics Robert Shiller is sounding a cautionary note on the U.S. stock markets’ Trump bump.
JESSICA HILL / THE ASSOCIATED PRESS FILES Yale University professor of economics Robert Shiller is sounding a cautionary note on the U.S. stock markets’ Trump bump.

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