2013 Nobel Winner Shiller Sees Wall Street Bubble

by John M. Curtis
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Copyright December 2, 2013
All Rights Reserved.                                      

           Winning the 2013 Nobel Prize in economics, 67-year-old Yale University economics professor Robert J. Shiller expressed concern about the latest stock market bubble that watached the Dow Jones Industrials more than double since President Barack Obama took office.  Closing today at over 16,000, the Dow stood at around 8,000 when Obama placed his left hand on the bible Jan. 20, 2009.  Shiller’s worry stems from the Federal Reserve Board’s artificially low interest rates that have driven a furious stock market rally since the Dow bottomed in the so-called Great Recession hitting 6,547 in March 20, 2009.  When Black Friday’s weekend sales numbers trickled in Dec. 2, they showed a three percent drop from 2012.  Last weekend’s decline was the first drop since the Black Friday numbers were tracked in 2006, hinting at an anemic holiday season to follow in December.

             Shiller’s main concern over a Wall Street bubble stems from the lack of substance to back the present run-up in equities.  If price-to-earnings rations get too high, equity markets don’t reflect underlying fundamentals that have to show concrete sales numbers.  “This holiday season is not going to be a gangbusters,” said Lindsey Piegza, chief economist of Birmingham, Alabama-based Sterne Agee.  “Retailers are bracing for declining activity from now to the beginning of the year,” proving Shiller’s point that underlying asset values don’t match today’s inflated equity prices.  Wall Street’s cliché is always that “earnings drive the market,” something not happening when retail sales show weakness.  Weak retail sales go to heart of a sluggish jobs market, where underlying weakness in the jobs suggest that companies haven’t fully recovered from the 2007-08 Great Recession.

             Given the Fed’s commitment to a rock-bottom monetary policy where the federal funds rates remains at record lows, it’s difficult to imagine another epic meltdown that took the Dow down from 14,000 Oct. 2, 2007 to 6,457 March 5, 2009.  Federal Reserve Board Chairman Ben S. Bernanke inherited a mess from former Fed Chairman Alan Greenspain Feb. 1, 2007.  After years of excess in mortgage-backed securities, the chickens came back to roost in 2008, when Wall Street’s Lehman Brothers filed for Chapt. 11 bankruptcy Sept. 15, 2008. When JPMorgan bought Bear Stearns for $2 a share March 17, 2008, financial Armageddon hit Wall Street, triggering the slide that eventually bottomed out in 2009.  Since there’s no looming financial crisis, it’s doubtful, despite Shiller’s warnings, that Wall Street will go through another comparable meltdown anytime soon.

             Periodic profit-taking is healthy for equity markets especially when they’ve escalated too quickly.  Shiller’s book 2000 “Irrational Exuberance,” explained what happens to stock market bubbles when the market gets ahead of itself.  Borrowing his title from master wordsmith Greenspan, Shiller discussed what happens to Wall Street when price-to-earnings ratios get out-of-whack with stocks.  When Greenspan described the 1996 bull market as “irrational exuberance,” markets promptly sold off over 1,000 points, only to bounce back to another peak four years later when former President Bill Clinton’s bull market started to meltdown in March 2000.  “The boom in the U.S. stock market makes me most worried.  Also, because our economy is still weak and vulnerable,” Shiller told the German magazine “Der Spiegel.”  “It will take a little time to tell,” said Shiller whether Wall Street has reached a critical mass.

             Shiller’s CAPE ratio or cyclically adjusted price to earnings ratio could be moving toward a bubble.  “Prices have risen sharply in some property markets” as well as equities suggesting that something “could end badly.”  Shiller sees the global economy as vulnerable to bubbles though he can’t point to another meltdown in real estate or financial markets.  With Bernanke protégé Janet Yellin starting Feb. 1, it’s likely the Fed will continue its “quantitative easing” bond-buying program to stimulate economic growth.  Saying he’s “starting to get more worried about the market as it keeps going up,” Shiller won’t predict a market correction.  Enough concerns about a Wall Street bubble could trigger profit-taking, perhaps taking markets down 10%, not the 20% drop seen in real market corrections.  With the Fed pushing the pedal-to-the-metal, major corrections aren’t likely.

             Winning the Nobel Prize in economics Oct. 13, Shiller commands more clout but doesn’t call the shots on Wall Street.  As long as JPMorgan and Goldman Sachs see more room for Wall Street’s upswing, a major sell-off isn’t in the offing.  “I am not yet sounding the alarm.  But in many countries stock exchanges are at a high level and prices have risen sharply in some property markets,” said told Der Spiegel, referring to the real estate boom in the U.S. and Brazil.  Whatever Shiller’s worries about asset bubbles in the stock and real estate markets, Wall Street has Bernanke and next Yellin to continue QE3’s ongoing safety net.  As long as the Fed keeps interest rates at rock bottom, Wall Street’s profit-taking will be kept to a minimum.  Without a major geopolitical calamity, global equity markets should supply the capital needed to continue expanding businesses and adding jobs.

John M. Curtis writes politically neutral commentary analyzing spin in national and global news.  He's editor of OnlineColumnist.com.and author of Dodging the Bullet and Operation Charisma.