» Posted by Martin Weil on July 28, 2007

The stock market sell-off this past week sent me scurrying to reread Robert Shiller's landmark examination of the 1990's stock market bubble Irrational Exuberance. It was a sobering read.

The parallels Shiller draws between the "New Era" thinking of the Gilded Age, the Roaring Twenties, the Nifty Fifty era and today are all too striking. The implications for investors, if these previous eras' denouements are to be repeated, are that it may be extremely difficult to make money in stocks, US stocks at least, over the coming twenty years. Shiller suggests that long-term generational bull markets in stocks, such as the one we have enjoyed since 1982, have had a strong tendency to be followed by long periods of very low or flat average returns. Such an outcome would wreak havoc with current assumptions about long-term investing and asset allocation theory.

While I have largely refrained from mixing political commentary with investment analysis in this space, one particular quote from Shiller (who does not so refrain), struck a very deep chord.

If we exaggerate the present and future value of the stock market, then as a society we may invest too much in business start-ups and expansions, and too little in infrastructure, education, and other forms of human capital. If we think the market is worth more than it really is, we may be complacent in funding our pension plans, in maintaining our savings rate, in legislating an improved Social Security system and other forms of social insurance. We might lose the opportunity to use our expanding financial technology to devise new solutions to the genuine risks... that we face.

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