Irrational Exuberance (2000)

I have just finished Irrational Exuberance by Robert Shiller. I am aware that there are updates, and new editions, as the edition I read was released in 2000 before the `Internet Bubble' burst.

I am wary of quoting too many of the passages that he wrote here. It is worth reading the book. Like a lot of the other literature, much time is spent on discussing whether or not the market is efficient. In an efficient market, you could safely leave people to do as they pleased since timing would neither help nor hinder them. I think Shiller makes a very compelling argument that this is simply not true. In this edition he closes the book by making various suggestions as to how we could improve market efficiency and opens the debate as to how we can prevent some of the wealth destruction. 

A large part of his discussion centers around the flow of information, and how that is used. Market Efficiency is based on perfect information being available. And it is true, we have easier access to an absolute wealth of information. The thing is not so much the availability of information, but also the ability to process that information. Ability and willingness. A lot of investors are not professionals and often `play the market' as a source of entertainment. In addition people have a lot of other things to worry about.

Shiller:

On the average investor...

'During the most significant financial events, most people are preoccupied with other personal matters, not with the financial markets at all.... People think they know more than they do. They like to express opinions on matters they know little about, and they often act on these opinions'

On the essence of the EMH:

`At its roots, the efficient markets theory holds that differing abilities do not produce differing investment performance. The Theory claims that the smartest people will not be able to do better than the least intelligent people ito investment performance. They can do no better because their superior understanding is already completely incorporated into the share price.'

One of his most convincing rebuttals:

'Stock Prices appear to be too volatile to be considered in accord with efficient markets. If stocks prices are supposed to be an optimal predictor of the dividend present value, then they should not jump around erratically when the true fundamental value is growing along a smooth trend.'

And, lastly a warning about another risk that EMH can incorrectly lead people to thinking that Equities will always outperform:

The evidence that stocks will always outperform bonds over long time intervals simply does not exist... at least one genuine fundamental truth about stocks: that they are a residual claim on corporate cash flows, available to stockholders only after everyone else has been paid. Stocks are therefore, by their very definition, risky.

For the most part, I think Shiller's book for me is a warning against accepting too closely conventional wisdom without doing your homework.

The stock market is after all just a price setting mechanism for businesses. Once set though, the price acts independently, and while there is an argument for the availability of information, a belief that in general, the aggregate average interpretation is right is not one that I subscribe to. 

As always, I am happy to read arguments that may convince me otherwise, but I think it is both possible to create and to destroy wealth over time.

My aim is to try find measures to help people stop themselves from destroying wealth.