Friday, 12 June 2015

Robert Shiller's Irrational Exuberance Returns, Just in Time

When Robert Shiller, a Nobel Laureate and Professor of Economics at Yale University, first wrote and published Irrational Exuberance in 2000, he warned about the dot com bubble. The bubble burst one year later.

In the second edition in 2005, he warned that a housing bubble was forming and a bust duly occurred in 2008 causing a deep recession in America.

Now. for the third edition in 2015, he added a section on the bond market, and right on cue, we are currently seeing turmoil in the bond markets. He also touches on the high valuations of the US stock market but he says he has no idea when a correction would occur.



The book explains forces that move all markets up and down. It shows how investor euphoria can drive asset prices up to dizzying and unsustainable heights, and how, at other times, investor discouragement can push prices down to very low levels.

Applying his wisdom and looking at the current situation in equity markets, the Chinese markets appear to fit his description of irrational exuberance, after recently climbing steeply and reaching very high valuations. Shenzen and Shanghai has rocketed upwards, driven by buying on margin.

Coupled with the moderating growth and the not so scientific skyscraper theory, which states that a recession would occur after the construction of very tall skyscrapers (read a Business Insider article on this), there is a growing concern that irrational exuberance may eventually cause massive pain to investors.

Look at the trajectory of the Shanghai and Shenzen markets below




Apart from the Chinese market, the global bond market is facing huge pressure due to the predicted interest rate up cycle which the Fed must eventually start. This unfortunately may also potentially hurt equity markets in Asia.

Meanwhile, there is also a property boom in many countries in the world driven by liquidity due to ultra low rates set by central banks throughout the world, and this may also be a potential risk factor when rates start to go up.

Closer to home though, only the real estate market remain high with other assets starting to deflate last year. Commodities have raced to the bottom, and while no crash occurred so far in the stock market, it has been dragged by mediocre profit performance of many companies.

Although the underlying economy is still strong and we are nowhere near the situation during the Asian financial crisis in 1998, unfortunately any shocks in the global market will still affect Malaysia. The best we can hope for is an orderly reduction of prices in markets where bubbles exists rather than shock and panic.

Note: You can also read my posting last year about this topic - Asset Prices Can For Up For a Very Long Time But Can't Go Up Forever

Razali is a financial writer and investment advisor. Email razali@laburniaga.com to ask about his services. He also runs a Malay writing and translation business. Visit www.translate2malay.com for more information. He has written three 4 books about stock and unit trust investments in Malay and has a Malay investment blog called Risalah Labur Niaga.

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