Masters in Business: Yale Professor Robert Shiller (Audio)

about investor behavior for really a long time. You know, early in my career, I became very interested in investor behavior and the cognitive errors that people in general, but specifically when we're making risk reward decisions and making bets on on markets or bonds or stocks or what have you. Those specific errors are quite fascinating. And when I began exploring that area, not a lot of people were doing

serious academic research and writing about it. And and Bob Schiller was really one of the first academics to say, hey, the math doesn't add up. Markets maybe sort of kinda a little efficient, but the numbers aren't there to justify this belief that markets are perfectly efficient. In fact, when you see the day to day and week to week swings looked at against dividends, which are really the ultimate

payout of of future earnings. The numbers just completely destroy the argument that that people are rational, markets are efficient, etcetera. So he's really a fascinating guy, not what you would expect from an academic. Uh, really down to earth. I've been on a number of panels and in media appearances with him, and I just always find him to be charming and pleasant. I've given him numerous opportunities to throw people under the bus, and he refuses to rise to

the bait each and every time. Uh. If you're familiar with his track record, or if you're unfamiliar with his track record, he's the guy who published the book A Rational Xuberance early in two thousand pretty much marked the very top of the market. As if that wasn't enough, in two thousand five two thousand six, he warned that housing was wildly overvalued and was due for a significant correction. Oh and by the way, we should expect that correction

to have a real negative impact across the economy. He was dead right about that, and today he sees markets not as quite in bubble territory liked or as as bubblicious as we saw housing was in two thousand five, two thousand six. But he thinks markets are fairly valued and that they could have a couple of years to go before we start to run into real, um serious problems. So really interesting guy, fascinating curriculum vitae. And still you know he really just wants to be a professor. He

he teaches a class every day. He's been up in New Haven at Yale for many years. Really sharp guy, very fascinating discussion. Without further ado on my part, here's our conversation with Bob Schiller. This is Masters in Business with Barry Ridholts on Bloomberg Radio. Today. I have a very special guest, our second Nobel Laureate uh Yale, Professor Robert Schiller. If you don't know who Professor Schiller is, well, first, shame on you. You should. And second, let me give

you just a brief background on the professor. You've been teaching economics at Yale for thirty two quite a while. You've written a number of books. One of the most famous books was called Irrational Exuberance, which came out in the year two thousand, in which you had warned about the coming dot com implosion. That wasn't the first time you had warned people that things were going to be

a problem. In two thousand and six, you were describing the subprime problem and what it was gonna do for housing and said, hey, we're looking at something we haven't seen in many, many decades, big drop in housing prices and loan behold. I think nationally we saw a thirty three percent drop. You're the co creator of the Case Schiller Housing Index, with which also measures house prices in

both cities and metropolitan regions. And and basically you were the first to really quantify changes in home prices nationally and internationally. And then last year, for all the work you've done on behavioral economics and finance, you were the recipient of the Nobel Prize, which you actually shared with someone else from Yale or am I to know? The other two were both from Chicago, Eugene Farmer and Lars

Peter Hansen. And and we'll save the whole wonky argument about Fama versus Schiller in terms of our market sufficient or not for a later segment. But Professor Schiller, well, welcome to the show. My pleasure. So let's let's get into the background of this. You've found your way into a field which has become known as behavioral economics or behavioral finance, before anyone even knew there was such a thing. How did how did that come about? Well? I never know.

It's uh apparently because actually there are antecedents. I had a professor at Michigan, George Katona. He was the guy who created the Michigan consumer sentiment indexes, which are still widely exited. And when did he create that? That was quite a way. Oh yeah, he did his first sentiment index in the nineteen fifties, So that was an early

exposure on your side to consumer sentiment. But nobody had ever taken that and really directly applied it to Yeah, he was in the psych department and he was all by himself. Yeah, I don't know who. It must have been someone else, but but no one else was really saying, hey, let's look at the psychology of consumers to see how what they're feeling and saying effects their behavior in terms

of spending and retail sales. Well, there weren't academic so there weren't scientifically there must have been people talking about psychology they've always talked about it. But the idea of systematized you know, it was in the early sixties that the Chris tape came, so you could use a computer and you could process an analysis of stock prices, and that kind of dominated thought. From nineteen sixty two almost nine. They were finding that markets looked efficient. That was the

general tenor so. The whole idea that you could beat the market, at least among academic types was considered discredited, and so they weren't interested in psychology. There was no psychology in this frame of thinking in the markets. And yet when you look at the behavior of markets in actuality, you have giant booms, you have bubbles, you have terrible busts and crashes. You know, in seven the Dow lost

in one day. How efficient is a market? Then on one day it's worth a hundred and then the next day it's worth seventy seven, and both of those prices are actually valid according to that sort of approach. How does that make any sense? Well, you're referring to October nine seven, when, as you say, the market made a historic one day dropped and efficient markets. People would say there must have been news that the problem is, no one could come up with what the news was, and

so it started to sound funny. I did a study of that event, but my way of studying it was totally out of fashion. I did a questionnaire survey. Now most no one else did that until later there was this Brady Commission that did a survey. But you know, the economists have gotten into the frame of mind that there's no point in asking people why they bought or sold because they lie. They make up stories, nationalized, they lie to themselves. They don't know they're lying. This looks

like psychology, which is just disreputable. In the econ department, I found that whenever you talked to people who were bullet the question to always ask is, so what's your investment posture? Oh, I'm fully invested, I'm long my own lots of equities. And whenever you talk to people who are bearish, it's always, oh, I'm out of stocks. I don't want to have any exposure. It seems that the way we define ourselves is rationalizing the prior decision, right.

That's called cognitive dissonance. That's so so we end up with participants in markets who don't really seem to know why they're doing what they're doing, but they're constantly rationalizing uh that process to themselves. Right. Well, they these are

ring bells that psychologists have explored. So justification bias, which is something that Knomen and others have studied, people uh will feel they have to justify things there their self respect even when they're justifying to them selves, and so they tend to follow naive rules and they tend to do the same thing that they've done before. As you were saying today, my special guest in the studio is Yale Professor of Economics Robert Schiller, winner last year of

the uh Rivsking Award for Risk Bank Award. It's this technically not a Nobel for economics, but it comes from the right. They don't make up their mind what to call it, so all these different names that they use it at the Nobel Foundation, So we could just go with the Nobel Prize in Economics and yeah, that's that's good enough. Shorthand. So the segment, this segment, what I really want to discuss with you are the booms and

busts that it seems every market has gone through. We had the dot com boom and bust, We had the housing boom and bust. Lately, gold seems to be in the midst of imploding as we're speaking. It's in the eleven hundreds. It was nineteen hundred dollars not too long ago. It's lost about its value. Is this the fate of humanity? That there are always gonna be booms and busts, that

were always going to have bubbles? Ah, good point, I h Let me say in my Nobel lecture which I gave on that occasion, I tried to point out that efficient markets is actually the theory actually has some value. It's a half truth. So let's not go to extreme right, Maybe it would be more fun if we went to extremes, but price movements and markets often do reflect real news. The point is that sometimes they don't, and so it's not the pure efficient markets theory is not quite right.

So when we look back at this past decade, we've had, we had a dot, We've had it seems every few years we've had a major bubble. Why is it that human beings succumbed to this sort of activity in capital markets? Well, people succumbed to this sort of thing outside of capital markets too. It's called fashions. And fads. Henry Fielding said, fashion is the great governor of this world. It's true. We're you know, so much like the way we're dressed

and the laser your suit and tie. Yeah, I look very conventional here, right, it's all dictated gray flannel overcoat and this is the sort of stuff. So because so in other words, it's the crowd. It's because peer pressure. Everybody else dresses this way. So is that how the investors behave? Yeah, and no, there's no problem in doing what everyone else does in dress, doesn't matter. But if you do what everyone else does in investing, you'll just

have the market return if you're lucky. Some of the studies we've seen have said that the average investor isn't even forget alpha, they're not even generating beta, they're not even obtaining market returns. So how how significant is investor

behavior to those sorts of bad returns. Well, then people are vulnerable to sales tactics, and they might buy into some investment fund that has a very high management fee, uh which they were sold on it, and they fall victim to tricks like incubator funds that you know, you try to start a number of funds and one of them is going to do well by chance, and you start promoting that one. There was an old joke many years ago that you could send out the back in

the day when newsletter writers were popular. You send out ten thousand pieces of mail, and you pick a stock, and one piece of mail says, this stock is the greatest things, and slice bread. It's our next pick. You have to own it. And the other five thousand pieces of mail say this is a terrible stock. You want nothing to do with it. And then whichever half is right, that's how you market the next the next letter two, and people like, well, they were so right the last time,

So it's very easy for us to be fooled. I'm speaking with Yale professor Robert Schiller discussing booms and bus Let's talk a little bit about irrational exuberance, a phrase that was made famous in by Alan Greenspan, which I think many of our listeners will be familiar with. Green Spans irrational exuberant speech. What I bet most people don't know is that you're the guy who briefed him before that speech, and that was essentially your phrase that he

incorporated into his um his speech. Is that is that more or less accurate. Well, I know that. I I've met with the whole Federal Reserve Board with my co author John Campbell three days before that speech, and we were saying the market was the irrational, But I don't think I probably used the word irrational exurbance. So that was his own phrase. Well, it wasn't exactly his own. It was already around but not used. But we know what really made it famous was not the fact that

he used it. It was that markets all over the world dropped sharply as soon as he I believe the Japanese markets were open when he gave his speech, the U S markets were closed. They just dropped immediately, and people, what's going on here? Why would the Japanese market Well, you know, people in Japan were listening to his speech and they must have put it out on the news, and that was the basis of the full and the nick. Yeah, it was so absurd that he just uttered these words

irrational and he mentioned Japan in the same sentence. And now everybody forgets back in the late nineties, green Span was the man. He was moving markets. Since then, we've had a little bit of reputational damaged thanks to the most recent financial crisis. Today, my guest in the studio OH is Professor Robert Schiller of Yale, winner of the Nobel Prize in Economics. In and earlier we were discussing housing.

Let's have a little more detailed conversation about that. So you were the co creator of the Case Shiller Housing Index. Prior to that, there really wasn't a reliable set of national data that compiles all the different metropolitan and regional housing markets. Is that? Is that correct? We had? Well, it's interesting there were no price indexes at all until around the nineteen sixties. Strange because people had the Dow and there was none. Then the National Association of Realtory

I think they had a different name. Then UH created the Media and Home Price and they published it. It was kind of intermittent. Some months they'd missed and it was very jumpy. Then the sense, I don't know if you wanted all that. There was a new home price index that Census published, but it didn't track existing homes. It wasn't you know what what we Case and I developed. We wanted to at Wellesley College. We wanted a tradeable index.

We believed in markets for indexes so we wanted an index that represented the investment value of a existence, so to repeat sales indere like a stock market index. It shows the changes in the index reflect changes in prices of homes, not the change in the mix of homes that are sold. Right, So every year the NR every month the NUR data. That's a different set of houses sold, different every month. You guys try to focus on a region and make it look more like you're trading a

given house, given group of houses. So we were the first to publish a home price index that is like a stock price index. And that's been around for how long now, since the late eighties, and it was eventually sold to S and P. It's complicated. We so that the five service service, so that the core logic core Logic has a deal with SMP. It's kind of, you know, the way the world works, never never simple. So then in two thousand three you had an interesting paper at

I think it was Brookings. Is that right? Is there a bubble brewing in the housing market? So tell us a little bit about that. What did you see an oh three, long before anybody else was talking about um housing bubbles? What caught your eye that made you author a paper three years before the market peaked and said, hey, this is a potential problem. Well, one thing is, we did a questionnaire survey of homebuyers and asked them what they thought home prices would do for the next ten years,

and we got extravagantly high expectations. People thought, uh, something like ten percent a year increasing for ten years, so the houses will double every seven or so after already reaching record high levels. Uh and uh. We we asked about you know, general people thought housing was the great investment. They were a little annoyed with the stock market in two thousand three because they had bottomed out and they had a bubble burst, and they would write things on

the questionnaires they right. I am really angry with my broker. He he told me all these finance guys are a bunch of crooks. I want to buy a house something that I can see and believe. I know it's real. I'm sitting in it, I can watch it all the time. And that just became an attitude that drove, and then home prices got increased that record pace. The price to rent ratio went up, the price too, personal income racial went up to record levels. Uh. Price to GDP home

home valuation GDP. All three metrics had just gone three standard deviations away from the historically they went completely vertical. And one of the studies that you had written, and I don't remember if it was the three study, said that over a hundred years. Here's something that people are always astonished when I tell them this. How much of a return has a home generated net of inflation over

the past century. What are the numbers? Well, this is what I published in two thousand five in the second edition of Irrational Exuberance. In real terms from eighteen ninety to nine, there was almost no change in real home prices. So, in other words, after once you back out inflation, home prices were flat for a century century for a century. Now that does that include the tax real estate taxes

you pay the maintenance. So effectively, all of us who have big houses that we pay a lot of maintenance and costs for this is a money loser unless you like the house. Yeah, if you got to live somewhere. For a lot of people, it's a form of force savings because they have to pay their more page down each month. And if they are not irrational. When it comes to home equity loans, thirty years later, they have a house and they have no obligation. That's another thing

that was happening during the bubble. There were these home equity loans were proliferating. People were borrowing against How is it they buy a second house, some of them using the first houses as collateral. I'm Barry rid Helps. You're listening to Masters in Business on Bloomberg Radio. Our guest today is the great Robert Chiller of Yale University, winner of the Prize in Economics, creator of the Case Schiller Index, creator of the Cape measure, which we'll get into, and

relentless um popper of bubbles. You've been pretty good identifying when markets are in a bubble. You did it in two thousand with the dot coms, you did it in oh six with housing. What do we see as a bubble today? What? What's got You have to come up with another one? Well, I don't know. The stock market looks highly priced, the bond market looks highly priced. The housing market is going up. Um, these are good times for booms. So this is a boom and the question

has win will it end? I wish I were better at doing that. You know, I don't get the sense that you perceive the market now. I think we will agree stocks are at least fully valued, if not pricing. Bonds are pretty fully valued if not pricing. I don't know if houses I would not highly priced, but not that's where I was going going They have been going well, maybe not in the last few months. But I don't sense the same sort of warning from you today in that I heard from you in two thousand six about

housing or two thousand about stocks. This feels like so we still have We know that these cycles always end badly. We know there's always a bear market down the road, but it seems like you're saying this could run a few more years. So we're not at the level where, oh my god, this is crazy. It's really Hey, things are a little a little pricey. That doesn't mean they can't get even more pricey. I really wish I could. I keep trying to predict turning points, huh, And I've

been doing questionnaire surveys. You can find them on our website. I give these away. The problem is that it just can't make any sense out of them. I'm peeping to try. Maybe I'll have I'll share when we're done, I'll share some sense out of them. We we figured out the secret. I'll share with you later. It's a quantitative trick. I don't want to say it over the radio, but i'll that'll be the next, the next Nobel. It's a simple

moving average, and that's usually the um. So let's talk a little bit about Since we mentioned the Nobel, let's talk about you and professor Fama. He's at your Yale, he's at Chicago. I always thought that you guys had too very different philosophies, and I thought your philosophy complimented his. So let me just set this up in a nutshell. Eugene Fama essentially says markets are, if not perfectly efficient,

then very efficient. That price and then what that means in English is prices reflect all the available knowledge that's out there, and so don't even try to beat the market. It's almost impossible. You're better off just buying a passive index and and forgetting about it. And Fama famously inspired John Bogel, who went on to form Vanguard, which is now managing three trillion dollars, of which two trillion is

in all passive indexes. So as an academic, my experience has been most academics don't necessarily disagree with that as an investment strategy. Is that a fair statement brought passive intentions? Yeah, it's a question of degree. If you're talking to someone who is not really likely to be that interested or attentive to what he or she is doing, of course you don't tell them to try to beat the market. It's a it's a game that smart people can beat on,

and so you're not gonna win. It's like, don't go into the gambling casino and play poker with your life savings either to lose. So uh. But I think the other question is whether some people who try hard and who are smart and organized, whether they can beat the market. And I think the answer is yes, although maybe not as dramatically as you hoped, but yes, they're very rare, the warm buffets of the world and the dramatic right,

the guys who have have put up market beating them. Now, some of the efficient market people say, well, that's just random. But I don't. I don't get the sense you agree with that. No, I think at people who try hard have business sense, and you know it's work. I don't. Yes, it's not necessarily fun. I think you know lots of Uh, it's not intrinsically rewarding unless you have a certain urge to do that sort of thing. Some people love it,

you know, so maybe that's great for them. Most of us would rather do something else, right, as opposed to being handcuffed to a terminal and watching the market take by tick day by day. There are people who have demonstrated the ability to outpulform the market doing that, but

you're right, it's a lot of work. It's it's and then and then they can the last twenty years of their life might be a failure, even though because you know, it's not just people, that's their theories and their ideas, and the market can just work against some theory that was right. We'll be right again, but maybe not for the rest of your life. So these things come into and out of fashion. As as you said earlier, that's the problem. So you know, I'm I'm a professor, not

a professional investor. Somehow going into that field seem a little bit It would give me ulcers if I went into that as my full time job. Well, you have to you have to learn to accept that you can't control what the market is going to do and as soon as you accept the market goes up and down and I can't control it. The ulcers go away. Some people never get to that phase of hey, listen, sometimes it rains. I just have to remember to bring an

umbrella and not blame yourself. That that's exactly that's exactly right. I'm speaking with Robert Schiller of Yale University. So let's get back to the efficient market hypothesis. So on the one hand, Fama is this efficient market guy. On the other hand, he's at the what's now known as the Booth School, and at the time there is an anomaly that these small cap stocks and these value stocks seem to do better than the rest of the market, which is a little funny because no one's supposed to be

able to outperform the market. But yet he becomes an advisor to a company that tries to beat the market on a regular basis. They don't use the word beat the market, So what phrase do they use? I have it exactly, But it's something about identifying risk factors. So there's a value risk factor. So in other words, you're getting a greater reward for the capital you put at risk. Is that right? And that there might be a rational

reason why one would need to be compensated. It might correlate with something you're doing, or some tale risk that you have in mind that you don't see in the data. But it's important. These are kind of hypotheticals and he so he wants to uh, he has faith in the rationality of the market that he wants to say that you can't prove why these fluctuate why value stocks. I shouldn't say that I can exactly what he would say, but it has that quality too, And and your approach

is different. Your approaches. Hey, humans aren't especially rational, and in a crowd, they are occasionally very irrational. And hence these humans and by crowd, it could be a stock market, it could be any sort of market for goods and services, and that's how prices go so wildly out of whack. Yeah. Now, I think Farma is a brilliant man. Actually I admire him. But you know, a brilliance comes with slants or views

as well. And that's that's all it was, you know, when it comes down to I talked to him about fact. We kind of agree on the fact on the objective statistics of the market. So um, so you've viewed forecast a ball. You know, as Farmer would say, the fact that it's somewhat forecasting ball doesn't mean it's inefficient. His Nobel lecture was called two Pillars of financial modeling. The one pillar is market efficiency, the basic notion. But the other pillar is you have to say, well, what should

an efficient market look like? And it could be a little bit forecast herble. So so the two of you share a Nobel prize with the third person who's a statistician at Chicago and doesn't philosophically. He's really more about the mechanics of of crunching numbers, whereas you and Fama are philosophically very much I don't want to say polar opposites, but you look at the market very very differently. Well, I believe in broader social science. I believe in psychology, sociology,

political science. They all matter. When you wonder why is the market growing up and down? You have to think in terms of those broader disciplines. That there's a ten for economists to dismiss these people, and I think that's a big mistake. So early in your career you had a paper you published, do stock prices move too much to justify subsequent changes in dividends. So explain how you looked at dividends as a way to decide that, hey,

this market isn't really all that efficient after all. Well, people often forget that ultimately the value in stocks comes from the dividends they pay. If there were ever a company that the government said we're putting a special tax on you. We're gonna tax your dividends forever the company, the stock would be worthless because it's only value comes from the dividends. What about companies like Amazon that have no dividend but in the future. So that's the expectation.

Is you're buying a pricing stock now that one day is going to have a big dividend. That's right. So that's the lure. This is the podcast portion of our interview. By now you've heard the first hour of the radio interview, which goes by. I told you it goes by like that, right, It's it's so quick. Um, So I have you in the studio for a little while longer before we have to take you to your next um presentation. I know you're honoring a colleague from Columbia, and there's a handful

of things we didn't get to. I definitely wanted to talk about first before I forget. You now have an online economics course? What what is that called? Financial markets? Yeah? And and how can somebody access this? Well, first of all, it's free unless you want a certificate. You can pay for the certificate, but it's a free course on Coursera. Started a couple of weeks ago and it's running until December. You can sign up any time for free and you

can participate. And then we have now Coursera is a group joint venture of a couple of different schools or it's of course Sarah is a company uh that involves a number of universities offering some l M I T Stanford, Harvard, There's a whole list of really highly regarded schools. Yeah, there's a lot of courses that you can take for free, for free. It's it's it's a very so it's like going to Yale taking a course with Bob Schiller, but without paying fifty your tuition. Yes. And the other thing

is you don't really uh see me directly. You see me on the TV. There's there's I think close to forty students in my class right who signed up and maybe they're not showing up. And we know that the online courses there's a big drop off when when over the course of time. But you know, so they don't get to go to the front of the class and ask you questions when the lectures over. But this is the same sort of lecture you give. Yeah, it's the same. Last time I did this, I had We graduated eight

thousand with a final exam. We gave a certificate and we failed three fifty. I'm sorry, I feel bad about that. But you have to take a final exam. It's it's essay or multiple choice. It's multiple choice. Okay, well it's computer graded. I'm not grading, you know, so you're not gonna do eight thousand essays for free. And then at the office hours. Uh, students can send in questions. We just had one the other day. Uh. And how similar is this course to you know, a Yale Economics one

on one course. Well, it's a little bit shorter. We trimmed it down, but it's it's based it's based on actual lectures I gave to my class. So this is if someone were to say, Gee, I didn't get into Yale, but I'd like to take Bob Show's economics course. This is actually something they could do and it's no charge.

I think this is a revolution for the future. I don't know where colleges are going as this becomes more and more con academy and they even meet each other our students, Uh, they meet ups, they can blog each other, they have meetups. So kin Academy is something that started doing this to teach math, and now they've added dozens of subjects. You think that this is something that is a a change in society. This is a tech. That's a question that that we we have to wait and see.

I actually like to have real people in the classroom. I think people want to get to know their professor, which you really can't do or I can't get to know them when there's so many of them, for sure, not not when there's eight thousand sign ups. Um, that's an interesting technology. What what other technologies I'm a gadget head. I know you have a smartphone. What other technologies impress you or interest you or do you think might be

leading to societal changes? Oh, well, there are big changes coming. Uh. We were talking about the diet pill earlier. The problem is, are we and lots of people have written about this. Uh uh are are we arriving at a new society where there aren't jobs for most people? You know, it used to be you could get a PhD. And if you couldn't get a job, you could drive a taxi. But it's coming. We're gonna have driverless taxis before long,

not not too far. Used to be a taxi driver, you used to have to know something, You have to know your way around the city. Now they just plug in GPS, and so we're gonna eliminate the driver completely. And the question is where is this going? Young people today have say fifty or more years ahead of earning years. What are they going to look like? What are their jobs gonna look like in fifty years? It's frightening. So

what about something that's less frightening. Earlier we were talking about a diet pill that you go to the Midwestern America. Even you go to Europe now, which used to make fun of us fat Americans. Europeans are now giant and bloated. What what did you mention you thought was happening on that side? I was thinking that I don't know. I'm not a drug expert, but I think I wouldn't be at all surprised if in ten years they'll have a diet pill that not only works, but they'll tell you

it will improve your longevity if you take it. They'll say it's good for you, you better take it, and there won't be fat people anymore. So you think technologies and and biotechnologies eventually going to eradicate controlling appetite. There is this lepton hormone they discovered and they thought that was it, but it turned out not to work. But

we'll find that's the famine mode. We were talking about that earlier, that you could suppress that, but then your body starts to think you're in there's no food, you're in famine mode, and it tries to hoard calories and not lose them. So it's a matter of eventually figuring out the biochemistry. It's just this will be a bigger revolution than the birth control to really so now it was the only thing there They tell women take it because it will make it actually reduces your risks. That's

really interesting. So the technology, so here's what we're gonna have. We're gonna have people living longer but making less money. Who's gonna who's gonna pay for this. You you got me, And so we have no answer to Well, the only answer that I've been giving in my books is that we should think about the computer generated inequality that might come in the future, and let's make plans now how we're going to deal with it, don't wait until it happens.

And so the plans could take various forms. One of them is risk management. We could put people in risk management contract. It would be an insurance variety. Another one is a plan to raise taxes on the rich. I mean not to I'm not saying to make everyone equal, just to respond to exceptionally increase inequality if it happens. If it happens now, by a lot of measures, inequality in America today is at the widest levels since the

nineteen twenties. Um, do you think that if we continue to see things move along the path that they they are, and if technology continues and globalization and other factors continue to make getting a job more challenging, is that going to get better or is that going to get worse? Well, nobody knows it could get better. It could be that

it generates jobs. Uh so Uh. For example, the people talk about musicians They say the invention of communications technology created a winner take all effect that only the only the very best singers would who could make records or

c d s would would survive. But it seems to be going in another direct and that now the the communications technology allows so many different types of music to flourish that it's kind of creating more jobs for and then people will hear some of them and then they want to hire the person for their wedding or something like that. It used to be that musicians would tour

in order to promote the sale of their album. Now, the way the cost structures have changed, they release an album in order to go out to promote the tour. The way the record companies set up their contracts, these guys, unless they're selling a million copies, they're not making a lot of money. But when they go on tour, if they run it lean and smart, that's where they're making money today. So you're saying, we don't and everything else is changing, that we really don't know the future. That's

the scary thing. And and since we don't this, you know, we're talking finance here. Finance and insurance are really about an un certain future. It's about managing it, sharing your risks, hedging your risks. People forget that that that's a core element. It's not about beating the market necessarily. It's about managing risks in such a way that you can be a productive society and we can achieve our yours. Now that sounds eminently reasonable, and yet we seem to overlook it.

So I'm going to repeat what you just said. The future is unknowable. There are risks inherent to that. It's our responsibility to manage those risks, and how successfull we manage those risks will determine how successful we are. Financial is Is that a fair restatement? This is what This is one of the messages that my financial markets course.

There's an important technology that finance represents, and it's a technology of financing activities and doing it in such a way that people can undertake activities that would have been too risky for um. They can they can take you know you you venture capitalists will support a young firm whose probability of succeeding might be uh, but it's not going to be devastating because they'll spread that risk guard over many investors. So you make thirty or forty investments

into the winners. The big winners pay for all those losers. And that's a form of risk management, and that's what our civilization is built on. We're doing amazing things. Uh so we have cures for diseases. Pharmaceuticals. People who try to develop new drugs have a notorious failure record, but a few of them end up being, you know, worth billions. The lipatours and viagraas of the day, those are billion

dollar pills. And in other words, to get to those, they had to be willing to go through dozens and dozens of failures trying to solve a particular problem. They couldn't in order to get those Southbuster advanced financially advanced countries are producing these drugs that save millions of lives. They're not coming from backward, I should say, backward emerging countries that don't have a sophisticated way of promoting enterprise.

Now the count the argument people would say is, Professor Schiller, these emerging markets, they don't have the wealth that Europe with the United States has, How can they be expected to develop these sort of things. Fortunately, you're saying it's not a function of wealth, it's a for for it's a function of intelligent risk management. Unfortunately, these emerging countries are moving along. That is the story of our age.

They're coming up. So it's China, it's India, it's the whole Pacific Rim, It's places in South America and Turkey. And yet you know the news lately, when you avoid the horrible headlines about Ebola and isis whenever I read about India, which you know, you look at China as a huge success story, although there are stories now about it's also become an economic bubble, but India hasn't had that problem. India seems to be having a hard time. Forget the twenty first century. They have a hard time

with parts of the twentieth century. Half the country does not have indoor plumbing. I think that's the actual number of households don't have toilets and indoor plumbing. Their health care system is or i should say their public health system is. There. People dump garbage and effluence in the river and in places where people bathe. And Washington, how can in a modern and yet technologically there are very advanced country with lots and lots of software companies and

lots and lots of technology companies outsourced. How do we have such a bifurcated society in an immerge gene market that should really be doing so well? Well, they do have a couple of hundred million people living like an advanced country, quality of life, and it's well, this might be the story of our times. The world is developing into two divisions. The cosmopolitans. The people who are running high tech companies in India are very cosmopolitan people. You'll

see them here in New York. They travel around, they know the world. It's the locals who I worry about, people who don't develop this kind of sense of the world, and um, they may stay behind for a long time. I'm hoping now that this will develop better so that India will will These things will be the modern technology, financial technology will be shared more broadly, find its way from the half to the have nots in in countries like that. You know, we see nations like Vietnam, and

forget South Korea. South Korea is now a booming First World nation comparable to Japan or developed Western Europe. What about some of the other Pacific rim countries we we we he see. Vietnam was at one point in time a fairly agricultural, fairly aggregarian society. They seem to be coming along with a lot of other countries along that Pacific rim um. Technological powerhouses, manufacturing powerhouses. Is that the path out of of poverty for these nations or is

that just over oversimplifying it. Well, I don't think all of them can do the same thing, and we may be saturating the world with some kinds of product. Uh. It's this. There's a whole field called development economics that studies UH. I'm thinking of. There's a wonderful book by Danny Roderick called UH One Many Recipes One Economics. It's a book about development economics I recommend, and what he says that every country is different and they all faced

different problems. So you need a development economist to go in like a doctor and to try to diagnose the problems. It's not a simple thing to know. Often these problems are uh created by a culture that is resistant to modern ideas, and it can be very hard to dislodge that. So this is as much sociological and psychological as it is economics. Yeah, I wish these different departments would cooperate more. So, let's let's bring this back to the US, and let's

talk a little bit about UM stocks and valuation. Is the one thing we haven't talked about was a measure you created called the CAPE, the cyclically adjusted pere ratio. Described for listeners exactly what that is. I developed this in the eighties with my former student John Campbell. The idea is very simple. That price earnings ratio has been used for a hundred years or more to judge the valuation of a company. Earnings is what it makes you want to know how many years earnings do I have

to pay to buy share of this? Uh? But we we thought that the price earnings ratio is as it's commonly calculated is is a little bit inaccurate because earnings are so volatile from year to year. So we thought, let's just average the earnings over more years, so you're taking ten years instead of a single quarter or a single year. Turns out we weren't the first people to think of that, do we We show that that helps

predict read subsequent returns quite a bit. So in other words, when you're looking out at future tenure returns, when the CAPE ratio is high, you get worse returns. Right, ratio is low. So, in other words, trailing tenuere returns when they're low, when you're coming off of a period of either earnings are high relative to price or price or low relative to earnings looking for so essentially you're saying valuation matters. Is that that's the takeaway of the cape

ratio right now? We use this on index or sector indexes or not. So far we haven't used it on individual stocks because I think they ten years might for a lot of stocks it might not even be ten

years of runnings history. So but for indexes, uh, you know, like looking at the United States, who can forecast earnings anyway beyond saying well, they'll be similar to what they are in So if the price is high relative to what it's been doing for the last ten years, and maybe it's not such a great time to be in

the market. You know. McKenzie did a fascinating study on analysts forecasts of earnings and it turns out that over the past twenty five years, the consensus estimates of forward earnings by the analyst community has consistently been about twelve percent a year, but earnings growth has consistently been about six percent a year. So they've been twice as optimistic as they should be, the only exceptions being in the midst of bear markets, they've been twice as barish as

they should have been. They've been much more negative. So forecasting earnings doesn't seem to be what Wall Street does. Especially, I'm hoping they're getting better. By the way, from all these experiences, you would have thought that two thousand would have taught them a certain lesson. And to be fair, when we look at the NASDACK today, the NASDACK is over four thousand. The P ratio is so much lower than it was back in two thousand when when markets

had gone crazy. From from October to March two thousand, that six month period um, the NASDAC doubled. It went from twenty hundred to five thousand, and then proceeded to collapse down to eleven hundred, and the p ratio was over a hundred. It was something crazy, and I believe the SMP five hundred peaked. I'm doing this from memory

somewhere in the mid thirties forties. The cape ratio was in the forties in two thousand on the SMP five hundred, and let me remind people the SMP five hundred hit fifteen hundred right around the peak, and did not get over fifteen hundred until thirteen years later. So the forward forecast of the CAPE was low and the net returns were zero percent a year for thirteen years. So is that how investors? Because here's the argument that's been circulating

on Wall Street about CAPE. You know, the CAPE has been saying markets have been overvalued of the time for the past twenty years, but that's not really how you envisioned using the CAPE hasn't done that well overall for the last fifteen years anyway. Well, but the markets themselves haven't done all that well over the last you know, from the peak in two thousand to last year, effectively flat with lots of booms and busts in the middle. So really the way investors should use CAPE is a

forward expectations. Here's what you should expect your returns to be for the next ten years, either above average or below average, based on whether the CAPE is elevated or not. So how price he is CAPE today around range, So that's pretty that's not extreme, but it's still significantly It should be in the fifteen sixteen range. Is that about right?

Even at the If you look at what it suggests for returns, returns are still in real terms three or four percent predicted for the next ten years after inflation based on historically It's not a really solid prediction. You never know. But uh, if you compare that with the re turns you see on bonds, that's real, so it looks a lot better. Of course, it's risk here, but I think that at this point of time it is reasonable to have a substantial fraction of your portfolio in stocks,

even though they look pricey. What bond market is pricey too, So six stock bond portfolio that gets rebalanced on a regular basis is something that you wouldn't object to. Yeah, I don't want to be responsible if it crashes. Well, but we know what happens if stocks crash, everybody rotates into treasuries, so bonds do better. That's the whole ideas expensive. You know, people forget and and this is right up

your ally in terms of crowd behavior. In the midst of the crisis in O eight oh nine, so many funds had poured into US treasuries that the yield had gone negative. It was below zero. Here, I'm giving you a hundred dollars promised to pay me back in a few years. That sounds crazy, doesn't so much for for a rational xuberance on the fixed income side. Hey, I don't want to own stocks at any price. I'm want to buy bonds and only lose a little instead of

taking a risk in stocks. So a portfolio that that is pick a number seventy That seems to make sense over the long haul, even with elevated cape ratios where where they are and and too depends on your situation though, how much risk you can take. And people who are living in retirement, maybe that's too much stocks. So yeah, you have to talk to your adviser. I can't. There is no perfect portfolio for every let's so let's caveat this.

This we're talking very generally. We're not talking obviously. Someone who's eighty years old and living on a fixed income is going to have a very different portfolio than someone who's twenty and as a fifty year window till they retire, or someone who's especially risk averse or especially risk embracing. Those are two. All that stuff has to be personalized.

There is no magic formula for for everybody. So I want to go back to what you said earlier that you know stocks are fully priced, but we're not in two thousand territory. You said this feels sort of like six or so. Is that's just a guess, right? I mean, I'm not We're not quoting you as saying Bob Shiller says the market has four more years to run. You're saying we still haven't hit that crazy bubble level. See, and I think of political and sociological factors, Marc for

exact ample, we just elected a Republican Congress. Now, we could have reacted to the current situation by electing Democrats who might raise taxes on the rich. Maybe they were more stimulus, more infrastructure. I think that you wouldn't you think? Perhaps it's so hard to predict how people with Americans are returning to their roots, which is a free market belief in capitalism. So we put in these Republicans and that sounds good for the stock market. Maybe that's what

was part of what was driving the market recently. Well, but you've had a market that's going up since March o nine and Obama has been president. So we went, sorry, it tripled, it tripled, but it's up to right, So we The low in March O nine was six six six on the SNP five hundred. We're just about two thousand from spinning distance. That worries me, by the way. That worries me. Uh, it looks like it's something that there could be attorney, but I just don't know. But

here's the thing that everybody forgets. It's easy to start at the very low. In two thousand, the SMP was at fift hundred. So here we are, thirteen fourteen years later, we're barely thirty three percent higher than when we were where we were in two thousands. Oh and by the way, if you correct for inflation, that's I mean, we're right back where we were, So no net net So there's like sixty six to eighty two. It looked like you were flat, but really you lost sixty or seventy of

your portfolio because of because of inflation. So I'm gonna change um subjects on you again. And one of the things that I bet people don't know about you is that your good friends UM with a professor who teaches at Pennsylvania who goes Jeremy Jeremy Segal. Right, So did you two guys come to and by the way you two couldn't be I've done shows with Jeremy years ago. Um YouTube personality wise couldn't be more different. How did

you two guys ever become well? Uh, we went to graduate school at m I T together together and m I T. Being very orderly because you know their engineers. They had us show up for chest X rays diagnostic in alphabetical X so we were waiting in line. We had a long conversation. So he and I are actually very similar in some ways. I learned a lot from him, but we're interested in the real world. Now, economics programs are often populated by people who are interested in mathematics.

But we were both also, but I think we uh we we had similar fascination with both. That that's what makes very good. His famous book Stocks for the long run essentially edition of his and now you have a third edition coming out of a Rational coming out in February. So he's two editions ahead of you. That's not although I'll do it, it'll take me twenty years now, but you've had a lot more You've published a lot more

books than he has. So when when you guys are on the bookshelves, and he says I'm up to my fifth edition. You get to say, but look how many books I've and I understand you. Your families are close. You guys vacation together. Really that's that's quite that's quite fascinating. And that goes back to grad school at UM at M I t that's ah, that's amazing. So we've been talking about everything from valuations and bubbles to a rational um behavior. What sort of changes would you like to

see an investor behavior? If you can educate the investing public, what would you like to see the do differently than they're doing today? Well, that's an interesting question. First of all,

I've said before they should get an advisor. Uh. Secondly, I think that we need better investor education because people could know a lot more about Thirdly, if we had better appreciation of finance, I think people could participate in products that would help them manage risks to their lives, like home equity insurance insurance against losses in the value of your home, or mortgages that protect you against home

price declines. And someday I think there will even be livelihood insurance that protect you against they drop in your ability to earn an income. Uh. These are things I talked about in my books. They're kind of futuristic finance. Have you been tracking the or following the new set of markets the allow you to invest in the future income of athletes. Have you been saying I talked about that in my book Interrational Zuberans in my book New Financial Order. Yeah, the so called Bowie bonds where you

could invest in David Bowie his future income. That worked out to be really good for Bowie. I don't know how well that worked out for I don't know what happened to David. Well, it wasn't just that. It was that record sales eventually fell off a cliff and he sold his catalog, so he took the cash up front instead of that's good for David Bowie. Yes, it turns out he's a savage. You shouldn't hold Bowie bonds as

the only thing in your portfolio. So if you held a diversified portfolio, a little a little Leonard Skinner, it, a little led Zeppelin it, it'll works go beyond just that sort of thing. So, so these ath there's a company out I think in California that's essentially doing the equivalent of I P O S where they take an athlete and they allow you to buy a percentage of his income and you don't know if he's going to get injured next year. What what sort of endorsements? That

seems like a kind of interesting form of speculation. Um, what sort of stuff along those lines? By the way, with Milton Friedman advocated something like this in the nineties sixties in his book Capitalism and Freedom for Everyone. We should all be able to sell shares in our income. Although then he kind of took it back. Milton Friedman had some sense of reality and he said, this is not for now in America, So we we all can't have individual I p o s. That's not gonna well someday.

But see he was commenting in his book that they're kind of hard to enforce, right, um enforce what trading people could? We could jump, they move away and then you can't find them anymore. So how are you going to capture a stream of That's what he said. Yeah, but if you're an athlete playing for a professional team, you can find them. So I always thought that was kind of a risky thing. You know, you an injury, you're done, you say something and forget the craziness that

happened with the NFL earlier this year. It's two. It seems very easy for an athlete to put his you know, not everybody's Lebron James. Not everybody is a Michael Jordan who's going to have a thirty year stream of UM endorsement revenue. Or look, you know, there are millions of golfers. There's only a handful of guys like Arnie Palmer and Jack Nicholas who when their golf career was over they

went on to build businesses, building golf courses. That that just seems like a challenging sort of ip O. So to bring that back to individuals, what else do you think they should do to too rain in the worst aspects of their behavior? How should people control their psychological im You need a therapist, Maybe you need some antidepressant. You know, we're medicating people and more and more people or probably I uh so, So aside from anidepressants, most

of our listeners are investors. What could they do to avoid the worst aspects of their own cognitive errors and behavioral foibles? Well, I think you have to be introspective and you have to understand psychology, and there are some important books that I recommend. For example, Daniel Kaneman wrote a book called Thinking Fast and Slow, which is a summary of a lot of important UM research in in psycho especially as relates to investing. It's a fascinating book.

It's it's a little thick, but it's definitely readable. He writes a very accessible style. What what else? Um? What sort of other books have caught your eye when you talk about emotion? Antonio Dimasio wrote a book called Descartes Error, referring to Renee Descartes. Uh was a philosopher hundreds of years ago who advocated emphasizing your rational self. There, Yeah,

he was. He thought that you had two sides to your mind, your rational and your emotional, and that the important thing philosophically is to just clear out all of the emotion. But Demacio said, you can't do that your brain. There is no clear division in your brain that you the emotions are built in. Uh. So that's another interesting book. So so when you say no yourself, be aware of your own you really is really a way of saying, hey, be aware of your own propensity to allow your emotions

to to get the best of you. So let's talk for a second about your own portfolio. Um. We we both had discussed passive investments and long term indexes. Is there anything else you do besides that? Or do do you walk the walk as well as uh? Uh? As well? Well, I am not. Uh My I have. I'm working with Barclays Bank on some investment products, but I leave a lot of the management of that to them because I can't do everything, and I'm not. I'm not watching individual

stocks on a daily basis. So you're an index investor. Is that a kind of statement? Not? Well, I do sector indexes. Yeah, I do some individual stocks, but I don't. Uh. I have a very busy life. I just don't have time to do um. I write newspaper columns, I write books. That's right. I left out your your columnist for the Sunday Business section in the New York Times. You're you're part of a group with let's see who else is

in that Tyler Collen, Greg manque Um, Richard Thaller. I'm trying to remember who else is in that room, that's right. And that's a murderous row of of writers there, to say the least. So it's fair to say you're not actively on a terminal trading every day. You're really a longer term. Uh well, I don't actually need money either. I think I'm all set for You're okay, and you're still working any plans all the time. No, I have no plans to retire full time faculty member. And that's

for as far for the next fifty. To spend time with my students too, I try to. I I have too many of them to do as good as I should. So I could keep you here for another hour, but I know you have an appointment. UM up after this honoring a a colleague of yours from Columbia University at the New York Times. So I want to thank you for how much time you spent with us. I really appreciate it. We've been speak taking with Yale professor Robert Schiller.

UM be sure and check out our previous podcasts that are on iTunes and Bloomberg dot Com. You're listening to Masters in Business with Barry Ridholts on Bloomberg Radio