Confidence: It’s one of the main drivers of economies and stock markets. But as Yale Economist Robert Shiller points out in a recent New York Times column, we still know little about how it works.
“There is considerable hope that the markets are heralding a major development: that Americans have lost the fears and foreboding that have made the financial crisis of 2008 so enduring in its effects,” Shiller says. “Hope is a wonderful thing. But we also need to remember that changes in the stock market, the housing market and the overall economy have relatively little to do with one another over years or decades. … Furthermore, all three are subject to sharp turns. The economy is a complicated system, with many moving parts.”
Shiller says that often-cited confidence gauges aren’t able to give insight as to what’s behind the changes in the measures, and aren’t able to show what factors of confidence drive which parts of the economy. He highlights some interesting data he’s collected on confidence, including what he calls the “valuation confidence” index. It measures the percentage of respondents who think stocks are not overvalued. Just before the market peak of 2007, the figure was about 80% for both institutional investors and individual investors. Through February of this year, it was 72% for institutional investors and 64% for individuals, he says.
Shiller also discusses the 10-year cyclically adjusted price/earnings (CAPE) ratio, which uses inflation-adjusted average earnings over the past ten years to smooth out annual fluctuations. For the S&P 500, it has averaged about 16 over the long term, and now sits at 23. “This suggests that the market is somewhat overpriced and might show below-average returns in the future,” he says. Still, the CAPE is well below its record of 46 reached during the Internet bubble. It isn’t that far below the 27 peak reached before the 2007 bear market. But in that case, the cause of the market crash wasn’t the bursting of a stock market bubble, but instead the subprime mortgage and financial crises, which most investors “couldn’t have known” would occur, Shiller says.
The bottom line for Shiller seems to be that unpredictability often reigns when it comes to confidence, and thus stocks and economies. While many have been getting excited about the S&P 500 nearing an all-time high, for example, he notes that using inflation-adjusted total returns, the index hasn’t hit a new high in 13 years. That means investors haven’t made real money in 13 years, which “hardly seems a reason for confidence,” he says. “But public thinking is inscrutable,” he adds. “We can keep trying to understand it, but we’ll be puzzled again the next time the markets or the economy make major moves.”
