Economist Shiller Warns of Bubble

September 14th, 2015 by

Nobel laureate economist Robert Shiller, among the most respected academics in his field, sees some troubling signs for equity investors who have been wondering where the stock markets are headed. He believes that another bubble in stocks is forming, not unlike the one seen at the turn of the century in 1999-2000.

As an aside, Shiller developed the home price index that is the favored gauge of the U.S. government. It now bears his name: the S&P/Case-Shiller HPI.

Whether or not there is a bubble in equities around the world is currently up for debate, though many experts have been making this claim for months. What’s novel about Shiller’s conclusion is that, even after the considerable correction that stock markets in both China and the U.S. experienced over the past month or so, the market is still in a bubble.

Source: World Property Journal

Source: World Property Journal

You can see from the chart above where a devastating plunge in home prices occurred during the lead-up to the financial crisis in 2008.

shillerMr. Shiller knows far more about economics than just how housing prices work, however. His comments about the current potential for a bursting bubble and subsequent bear market isn’t based on the housing market—and you can see in the chart that, during the dot-com bust that took hold around the turn of the century, home prices weren’t really affected (and, in fact, were on the rise).

Shiller is basing his most recent prediction on valuation confidence indices, which are measures of investor confidence in the market being correctly valued. According to these indices, the markets haven’t been this skeptical about stocks being overvalued since 2000 when the tech bubble popped.

He also uses the CAPE (cyclically adjusted price-to-earnings ratio) measurement to prove this point; this makes sense, considering Shiller invented the gauge. Using CAPE, stocks appear quite overvalued, but MarketWatch points out that CAPE has been indicating that stock prices are too high for several years, even as the market continues to go up. Does this mean the measure isn’t useful, or simply that investors are boldly ignoring its warnings?

Fed Watching

Somewhat surprisingly, Shiller insists that the ominous signs about the equities market have very little to do with the possible rate hike from the Federal Reserve. He bases this conclusion on the long-standing awareness in the markets about the rate hike, believing that nobody will be caught off guard if and when the increase to the federal funds rate comes. The volatility on the stock market, while possibly related to the level of indecision exhibited by various members of the FOMC, won’t abate even after the rate hike, Shiller has said.

What About China?

Zhou_XiaochuanNot only is China now at the center of the global economy, it has also been the hardest hit by the recent spate of market volatility. It follows that this development was an important talking point for the world leaders gathered at the G20 meetings earlier this month. During the communique, the governor of the People’s Bank of the China, Zhou Xiaochuan (pictured), expressed that the supposed bubble in China’s stock market had already “burst,” obviously an attempt to get in front of questions about the health of the Chinese economy. Despite what Zhou insists (and the 40% decline of , the other leaders of the G20 economies were less than convinced that the potential for a bubble to pop in China no longer exists. All indications, however, are that mainland Asia’s possible financial troubles can be resolved internally, may even be helped by the Fed tightening rates, and are nowhere near the vulnerable levels of the 1997-1998 crisis in the region.