Tag Archives: Robert Shiller

Robert Shiller: Worried About Housing Again

This past weekend in the NYTimes, Nobel-laureate economist Robert Shiller sounded the alarm on housing again. For those who don’t know, Shiller called the stock market bubble of the late 1990s and the housing bubble of the following decade. He is famous for his house price index and for his method of stock market appraisal called the “Shiller PE,” which judges price relative to past 10-year average real earnings, even if this latter metric comes from the great market analyst Benjamin Graham.

Shiller doesn’t use the word “bubble” in his article, but he argues that since around 2012 we have been experiencing one of the great housing booms in history. And this one is on the heels of the previous great boom and bust. (The third and more benign boom coincided with the great post-war Baby Boom).House prices are now 53% higher than they were in early 2012, meaning they have appreciated at least 7% annualized. Inflation, measured by CPI, since 2012? Less than 2%. That’s a big gain on CPI-adjusted grounds. The excellent graphic below from my colleague, Jesse Colombo, in a Forbes article, tells the price-CPI discrepancy story.

How is it that house prices can surge higher than inflation when median household income is mostly stagnant? Shiller places great importance on the psychological aspects of large price movements. He doesn’t think single economic factors typically tell the story — or the whole story. Therefore, he is skeptical that low interest rates are the primary cause of home price increases. There is some merit to blaming low rates, according to Shiller, and they have been present at the last two bubbles, but rates have actually been going up since 2012, while prices have continued to surge. As Shiller puts it, “The housing market does not react as directly as you might expect to interest rate movements. Over the nearly seven years of the current boom, from February 2012 to the present, all major domestic interest rates have increased, not decreased. So, while interest rates have been low, they have moved the wrong way, yet the boom has continued.”

Another possible explanation is economic growth. But house prices didn’t surge from 1950 through 2000 despite GDP roaring ahead sixfold during that time. And it’s not quite correct either to say prices are normalizing, because they are higher now than at the bubble peak.

Perhaps the home price increases are now a self-fulfilling prophesy, says Shiller. In other words, prices have been going up so people expect them to keep going up. Shiller quotes Keyenes saying, “people seem to have a “simple faith in the conventional basis of valuation.” If the conventional basis is now that home prices are going up 5 percent a year, then sellers, who would otherwise have no idea what to ask for their houses, will just put a price based on this convention. And likewise buyers will not feel they are paying too much if they accept the convention. In the United States, we may believe that the process is all part of the “American dream.”

The price surge can’t go on forever, but Shiller explains that nobody knows when it will stop. All we know now is that prices have surged  as they have only two other times in recorded history. Let buyers and sellers beware. And if you have questions on our views of stock and bond markets, please contact us here.

Citywire Article: Can You Spot A Bubble? What About Now?

This is my most recent Citywire article on an academic study of bubbles. Despite what Eugene Fama asserts, they have telltale signs.

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The return of volatility earlier this month set stock markets on edge, but are we really in bubble territory?

Two Key Indicators Show the S&P 500 Becoming the New ‘Cash’

Pension plan administrators do it. Their actuaries and consultants do it. Professional endowment and foundation investors do it. Financial advisors do it. Private investors may or may not do it, but they probably should.

Do what?

All of these folks already are or should be asking themselves the following question: What’s a reasonable expectation for the long-term return on a broad-market equity investment?

Professionals usually answer the question using complex models, and there’s nothing wrong with that, but we’ll keep it simple here. Simple often beats the snot out of a long white paper, and two recent developments beg for simple.

First, on Thursday the Fed released its flow-of-funds data, which includes an estimate for the household sector’s overall asset allocation. Data show allocations to corporate equities reaching 25.1% of total household (and nonprofit) assets, a level only before seen between Q4 1998 and Q3 2000. Here’s the full history:

spy returns chart 1

Now, you may say 25% is just a number, and we would agree, but only to a point. We don’t think the household sector’s current allocations tell us anything about the market’s near-term direction. In fact, we don’t detect any of the most common precursors to major market turning points, as discussed here. But we do think household equity allocations offer clues to long-term returns. Consider the next chart, which compares the allocation data to the corresponding S&P 500 returns over subsequent periods of six, eight and ten years:

spy returns chart 2

You’ll decide for yourself, of course, how to interpret the chart, but we’ll entertain three possibilities. First, you might rely on a few instances in which S&P 500 returns reached almost 4% after the equity allocation was 25% or more. Compared to today’s minuscule bond yields, 4% looks respectable. If stocks do, indeed, return 4% over the next six to ten years, that could be higher than the return on any other major asset class, which probably explains how stocks got so expensive in the first place.

Second, you might mentally project the scatter plot’s downward trend out to the current equity allocation. Doing that, returns appear to spread evenly around today’s cash rate of about 1%. So, whereas optimistically you might expect a return of 4% or thereabouts, more realistically a negative return is almost as likely.

Third, you might look at the data and say, “So what? We should really use a traditional indicator—one that compares prices to earnings—not an asset allocation measure.” Which brings us to another recent development that might alter future returns—the S&P 500 busting through 2500. To account for that latest market milestone, the next chart updates one of our favorite S&P 500 indicators, the price–to–peak earnings multiple or P/PE. (Unlike a standard price-to-earnings multiple that places the past year’s earnings in the denominator, P/PE uses the highest four-quarter earnings to date, mitigating distortions that occur when earnings fall in recessions.)

spy returns chart 3

At a price–to–peak earnings multiple of 23.6, we’re currently at about the same valuation as in December 1997. Once again, you might find an optimistic interpretation—that is, the long bull market that finally ended in 2000 suggests there could still be room to bubble up from here. But the implications for long-term returns aren’t nearly as optimistic, as shown in our final chart:

spy returns chart 4

If you stare at the chart long enough, you might see a less bearish picture than in the first scatter plot above. (Stare even longer and you might see the King of France.) But the difference isn’t especially large. On either chart, the downward slope points to a meager long-term return. In fact, if we use only the scatter plots above to make our estimate, while also accounting for the Fed’s predicted interest rate path, the S&P 500 appears to offer a similar return to cash.

Conclusions

To be clear, we’re encouraging long-term bulls to reconsider their assumptions, but we’re not advising them to dismantle carefully diversified portfolios (meaning those that are spread sensibly among multiple asset classes). We would be more likely to recommend a major portfolio shift if the usual bear-market catalysts—sharply rising inflation, high interest rates and poor credit conditions—were present.

More to the point, it seems a good time for investors to check their expectations and risk levels. Investors should develop reasonable expectations informed by data such as those in the scatter plots above. And they shouldn’t take more risk than they’ll be able to tolerate as the next bear market plays out. As always, only a small percentage of investors will accurately time the next market cycle, and we shouldn’t bet too heavily on being among those fortunate few.