ETF Edge - Special Episode: Nobel-winning Economist Robert Shiller

Episode Date: November 2, 2020

CNBC’s Bob Pisani spoke with Ed Clissold, chief U.S. strategist at Ned Davis Research Group, and Robert Shiller, Sterling professor of economics at Yale University and a Nobel Prize winner. They discussed how rising fear levels and high stock prices could impact markets, the upcoming election’s possible impact on the stock market based on historical data and long-term stock market performance and the economic recovery. In the 'markets 102' section Bob continues the conversation with Robert Shiller about the upcoming presidential election. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange traded funds, you're in the right place. Every week we're bringing you interviews and analysis and breaking down what it all means for investors. I'm your host, Bob Pisani. Today on the show, we'll talk to Nobel laureate and Yale University professor Robert Schiller about how expensive stocks have been getting. He's worried about that.

We're talking about standout behavioral trends he's seeing and the ripple effects of this week's presidential election. Here's my conversation with Bob Schiller and also with Ed Clissle. He's the chief U.S. strategist for Ned David Research. He studied elections and the impact on markets going back to 1900. Professor Schillel, I just want to pick up on our discussion earlier about your New York Times op-ed, where you said you were concerned about the potential high prices in the market. Can you tell us what's concerning you right now about the prices and whether or not that's impacted or related to COVID?

I think we have to look at what people are thinking, not necessarily what they're talking most actively about. So 30 years ago, I started surveying both institutional and individual investors. And what I've discovered with our latest results is that among individual investors, the assessed the likelihood of a crash is that, like 1929, that's a famous narrative, is that about the highest it's been, it is the highest it's been, In other words, my crash confidence index is at its lowest since it started out in 1989. So I'm worried about that. They also think the market is, the valuation confidence is low, especially for retail investors.

But it's true for institutional investors as well. They're on the low side, both crash confidence and valuation competent. So that puts me wondering what frame of mine are we in now? We had a long discussion at the end of last year about your book on narrative economics coming out. Are you sort of suggesting here that because the fear is very high that people can talk themselves into a market crash? I mean, what's the implication for people having a market narrative in their head that the market could crash? Because the market did have a pretty big drop 30% just a little while ago. And we sort of went through that and the markets are back with tremendous stimulus.

Is there something that's concerning you now with this narrative that people have in their heads that somehow they could wish it to happen? Yeah, what happened between February 19th and March 23rd was the embellishment of a pandemic narrative. And the word depression, talk about the Great Depression. Now, they sound like very different things, but for a while at least we thought they were similar. And so maybe that's passed. You know, I'm not counseling pulling out of the market. I'm not being alarmist here. It does still have a excess return compared with alternatives.

That is pretty substantial. Yeah, you have a long history of warning about high-priced markets. You became very well known for that first edition of irrational exuberance talking about high stock prices, and that came out right as the market was topping out in the early part of 2000. as I recall, then you talked about high real estate prices, 2004 or 2005. Prices did top out. One of the issues that I have, though, is relative valuations. You talked about high bond prices a few years ago, and I think it was the third edition of irrational exuberance, and prices are remaining high for bonds, and yields have been raining low, and it looks like they're going to remain

low for years. So is it not unreasonable to suggest that the stock market, given the demand for stocks is reasonably valued compared to bonds ever at this point. Well, I don't know what reasonably valued means, but yeah, I'm advocating investing in stocks. So this is not a doomsday scenario for me. But I think that it's interesting to note that it is a time of exceptional uncertainty as I've measured it. And I don't have the ability to say what that necessarily means. It could be a contrarian indicator, and it could mean that it's a good time to invest. I think you have to—the market is very complicated, and it depends on the interaction of multiple narratives.

And so I think that the mindset that people have today is a bit fragile. And the election coming up is in the works as creating a sense of dread, which might—there's something that psychologists call it the— affect heuristic, that when you're worried about one thing, you tend to be worried about other things as well, if they don't drive your attention away. And if there's another shock downwards, I think there could be a reaction among other investors. And I'm pointing out as a possibility, not at all a certainty. But the stark reality is that people are fearful that this is 1929 again. I'm not making that up.

It comes from my surveys, and they think the market is highly priced. This is a bad combination. It could be a bad combination. I don't know the certainty what the future will bring. I think people should be aware of that and not over-focused or overexposing them to, say, information technology risks. Yeah. Ed, why don't you weigh in here? you're the chief strategist over at Ned David Research.

What do you think of what Professor Schiller is saying? Is this a bad combination that we have here with high prices and high anxiety levels, essentially? And what's your view on what's going to happen in the next few months? Yeah, if you're talking about valuations of the market, I think one of the challenges is trying to right now. And if the economy reopens, it's reasonable to think that that. So do you, I mean, obviously what happened last week is a manifestation. of what you were talking about. I mean, since 2002, the narrative, as Professor Schiller would say, the narrative has been that 2002 was the earnings bottom. Two thousand three was better.

And 2004, excuse me, Q2 was the bottom. Q3 earnings have improved dramatically. We see that already. And in Q4, they're going to get even better. And even better in Q1 and Q2. And suddenly we're going to get a vaccine and it's all going to be a party at that point. That seems to be the market narrative. It was interrupted last week when all of a sudden it became clear that the reopening narrative is not going very well, that we're not slowly marching towards a reopening and there will be stimulus, additional stimulus as a bridge to the vaccine. Both of those narratives, the stimulus and the reopening story kind of got interrupted last week and the market had a bit of a hiccup. Do you think those will be resolved? If you look today, the market seems to believe

that there's going to be more stimulus because all of the stuff around stimulus is doing better today. Dynamic because, you know, they didn't go down. Usually, that didn't happen. So it wasn't odd. The way we interpreted it, we're going to get through the Pender. Hey, this is going to work. And then maybe not as well as we had earnings. Is that in Q2, expectations were so low for the data.

Yeah. Before I move on, Professor Schiller, I just want to get your thoughts on bonds because we sort of have to finish that. discussion. You've also warned about high prices of bonds for a number of years. Bond prices are still high. I'm wondering if you see any change in that at all. It's hard to imagine somehow bond prices dramatically coming down unless there's some dramatic inflation shock. Do you have any idea or thoughts about what bond prices might be doing in the next couple of years? Well, bond prices have mattered very much for the stock market in certain episodes. I'm thinking of the 1980, 1981, 82 recession and bond yields.

You might have thought then, back then, that they'll never go down. Bond prices will never go down, but I'm sorry, bond yields will never go down. But they did. So with my recent paper with Farooq G. Raj and Lawrence Black, we look at how, you know, a spread between the inverse CAPE or the CAPE yield and the 10-year Treasury has explained returns. It does explain excess returns between stocks and bonds. So it looks good at the present time because interest rates are so low. And this kind of analysis takes account of both of the possibility that bond prices will decline in the near future.

and just the spread between bond and stock returns. So, yeah, I think for a long-term investor, it's not bad. It's not as good as it's been, the outlook relative to bonds. But bonds are certainly at an extraordinarily low yield right now, and that has to be affecting investors. It's not the only thing at all, but it's part of the narrative that's driving, has kept stock prices so high. But it lives along with this other narrative about 1929 and about how stock prices were so high and people didn't believe it.

Many people got crushed in the 1929 crash. And that's still there. It's still on many people's mind. It's like a folktale that they grew up with. And they're reminded of again now. Yeah, I agree. I just want to move on to talk about the presidency and the markets because, Ed, you and I spent some time last week talking about the markets. elections. There's a couple of very unusual things about this year, or one of you can comment on that,

particularly that we've had a recession in this year and a 20% drop in the markets, and you and others have noted that historically that does not bode well for the incumbent. Can you explain that very briefly? It's 1900 in years when you've had, and the incumbent party is over. You'd have to go all get blamed for it, and he'll get reelected. But I agree with your point. This is unusual in that you've got the 20% drop in the markets and a recession. And an incumbent hasn't won under those circumstances since Truman. Is that right, Ed? With these two things against you, your point is this is pretty tough to overcome,

but it's not clear whether the electorate will blame Trump or not for this. What's always amazing to me is to point out the people that the stock market has gone up historically, regardless of who's in the White House. Regardless of whether there's a Democrat or a Republican in the White House, the market tends to go up. They're under Democrats. This is adjusted for inflation. Ed, these are your numbers.

3.8% when they're in power and on the Republicans. It also goes. The point is it goes up under either one. And under, I think the important distinction you were trying to make in our discussions last week was what happens when the Congress is involved, how do markets act when a Republican controls the White House and the Congress, or a Democrat controls the White House and the Congress, or a Democrat controls the White House and the Republicans control? And here's the results, Ed. And again, what's remarkable to me, Ed, is it goes up no matter what, although the best scenario is when a Republicans are in the White House and the Congress. I want to you to just comment.

What's amazing to me is this is going back to 1900. Your numbers here, and they're all up under no matter who's there, better under Republicans and Congress, both controlling the White House and the Congress. But why is it that the market tends to go up no matter who's in office? Can you just sort of comment? I think that's the most amazing thing about this. Well, I can't create the differences between the parties. This is still a country.

And so, I mean, and you can find. Yeah, Professor, I wonder if you could comment on that. Ed was sort of bringing up this narrative. Yeah. You know, your term about this, that the president isn't as influential in the economy as many think, but there's a lot of factors. There's a lot of stories and narratives behind what drives the stock market. And it's not necessarily the president.

We're in a capitalist society, as Ed mentioned, and we've got a court system. I mean, there's other narratives here besides the president is the emperor narrative. First of all, let me say, I think Ed and I are kindred spirits. We both like to look at history. And you went all the way back to 1900. That's great. That made me think, dredge my imagination. You know, there was a similar experience in 1876.

That's before your sample began, when there was an election between Hayes and Tilded. Right in the middle of a depression, by the way, 1873 to 79 depression. And Tilden won the popular vote, but lost the election. And there were also talk of cheating, and they had to go to the Supreme Court, I believe, resolved this issue. You know what happened? The stock market didn't do anything. So you can't, it's hard to generalize about these experiences.

They're all different because they, the narratives are different. different. Some of them might be similar, but it depends on how they trigger other thoughts and narratives. So I think there's a lot of unscern. I really don't know what's going to happen tomorrow in the election. I think there's a danger. I list these factors of the crash confidence and valuation competence as kind of like risk factors, just like there are risk factors for COVID-19. Some people, like older people, are more vulnerable. So I think that our economy is kind of vulnerable because of a bad affect and a loss of trust that everyone, both sides are claiming the other side is lying.

And that has never happened before, so it's hard to prove what that will mean. I still think that the situation means a tumultuous market in the coming days. And you have to think about whether you want to put your long-term time. investment in now or to wait a while for this dust to settle here. And I don't know the answer. It's a difficult thing to decide. Yeah, it's certainly very difficult. What it looks like right now is a lot of people are still trying to look over the hump here and to the prospects for a vaccine stimulus and the gradual reopening, although it's certainly a lot of hiccups in that market. Now it's time to round out the conversation with some analysis and perspective to help you better

understand ETFs with our markets 102 portion of the podcast. Today we'll be continuing the discussion around elections and behavioral economics and the importance of narratives in economics with Professor Robert Schiller of Yale University. Professor Schiller, while I have you, I just want to bring up that book that you wrote, oh, close to a year ago about economic narratives. We had such a wonderful discussion eight or nine months ago. The book was about the importance of storytelling and economics, And it focused on how humans understand the world by telling stories. And while most people don't understand obscure economic theories, they certainly do understand about how the impact of the economy can affect their lives.

So this was a great book. And I'm wondering what kind of narrative kind of exists around COVID and the economy right now, or is it too early? Have we not gotten that? Since you're very good at explaining stories, and I'm a journalist and a storyteller, I pay a lot of attention to this idea of narratives. What is the narrative do you think the public has right now around COVID and the economy?

Yeah. Unfortunately, it's a complicated question. There are many narratives. I call them constitutions in narratives. And there are some old ones that can come back. It's like influenza. A narrative is like influenza. If there's a mutation or something changes in the contagiousness because of change in the environment,

it can start spreading by contagion again. Some narratives are just not very good if you were to rate them on their literary value, but they're good because they're somehow contagious, and so they keep going. I'd like to mention the narrative of George Washington and the apple tree. He cut down an apple tree, end of story,

or he didn't lie to his father about it. That is the most feeble narrative, but it's contagious because people use it to teach values and moral and patriotic feeling. Somehow it's contagious, and almost everybody knows it. So what is the narrative now?

Well, I think that an important one of these list of narratives is the so-called V-shaped recovery narrative. Maybe that's starting to fade. But after March 23rd, which also came at a time of Fed announcing dramatic, aggressive stimulus policy, the market did a V-shaped recovery again. So is that because of some fundamental information, or is it because the narrative?

So people thinking in March of 2020, they still remember the stock market collapsed in 2008-2009. And so they remember regretting. A lot of people remember regretting not getting into that. when the Fed did this dramatic stimulus. So they're not economists, but they just know what happened last time. And people tend to overemphasize what happened last time. We made it happen again. But that story, the V-shaped recovery story is starting to get a little old.

And the market looks expensive, not just to me, to them, to the public, as my surveys reveal. Yeah. And so that may not be such a strong narrative going forward. You know, you write about the narrative around COVID. It's very, very complicated. Like, if you just look at the resistance to the mask wearing, what is, what's around that whole thing? And the narrative seems to be some narrative about freedom, for example, and resistance to the idea of wearing mask as an infringement upon freedom. There may even be some class narratives round up in that.

I'm trying to think of the way you thought in the book, in the book about economic narratives. So you're right. There's all sorts of complicated things wound up in this. So I'm thinking back to the last big, the even bigger epidemic in 1918 of influenza. And there was mask wearing that. And the medical professions was urging people to wear face masks. And there was the same resistance to it. And so what happened then?

That was a bad one. So we lost over 600,000 Americans when the top. population was smaller than it is now to that epidemic. There was a recession in 1918, 1919, but it wasn't bad. I think there was another narrative going on at that time, which kind of, believe it or not, crowded out that somewhat crowded out the emotional reaction to that influenza narrative, and that what it was was the end of World War I. Now World War I was a much better narrative story than the flu, because it was a much better narrative

story than the flu, because it was about courage and heroism and love for a country and all that. And so it was, that's how people viewed it. They viewed it as the, as the end of World War I. They had a big parade in Philadelphia, and they didn't do social distancing. And lots of people died after that parade. It was an armistice parade. So history repeats itself in that sense.

Yeah. Yeah. Let me just move on. You won the Nobel Prize in 2013. As I recall, it was for empirical analysis of asset prices, which is a fancy word of looking into efficient market theory and a little bit of behavioral research. I think there's been six Nobel prizes for what I would call behavioral market research or behavioral research in general. And it's had an enormous. impact that it has on me in the last 15 years and, you know, since your book came out, but with all of your colleagues who've won for essentially behavioral economics, I guess is there something we can learn from all of this long term? What's amazing to me is just how bad humans are at making decisions in general, how their brains constantly fool them into making poor decisions, which you and your colleagues have exemplified or categorized and cataloged in so many different ways, the heuristics we use from the gambler's fallacy on. Is there anything we can learn about this?

Can you sum up all this research for us and explain why humans are so bad at making decisions? They're not bad when it, they can be bad. We trust our doctors generally, don't we? Doctors, when they say you need surgery, how many people say, I don't believe you? Not too many. But this is the whole field of psychology. The big lesson that I learned from it is one about general education. I think there's too much specialization.

Specialization is useful in the modern economy. Of course, you go to a doctor for your illness. You go to a specialist even. But there's a downside to specialization. And I think that in our leisure moments, it's important that we maintain a kind of a general breadth of knowledge stance. Read history or read psychology. That's the basic lesson because otherwise you'll be talking to people who are too busy with their specialty to see the big and broader picture.

And you'd be relying on aphorisms rather than real science. That's the lesson I would take. Yeah, another thing that's amazing to me, and you've written about this many times, and you mentioned it in the book on narrative economics, is just how bad humans are of predicting the future. And not just astrologers, but the Federal Reserve is really bad in their economic forecasting. Analysts are bad at the economic forecasting. It's amazing to me. This is my 30th year at CNBC, and I've seen it over and over and over again, and yet here I go.

I quote analysts, I quote strategists all of the time, and yet I think to myself, you know, they're really pretty bad at this. Why are people, is there something inherently unknowable about the future? and asset prices and life in general? I mean, what do you take away from this? Yeah, yeah. You should read the book, The Black Swan, that talked about how people overestimate,

underestimate those big black swan. Nicholas Talab is the author. So that is true. There is a tendency to see your life as a logical progression rather than a series of accidents. So right now we're suffering through COVID-19. We were told it was coming sooner, some virus, some pandemic is coming sooner or later, but we just forgot about it until it happened.

And then we said, is this really happening? So again, I think the lesson is to try to become a renaissance person as much as you can. I think that's a success. I like to see some analysis of that. I think that's a success story. If you look at the college majors of CEOs, they tend to be all over the map. They're not all business majors.

My point was that you have pointed out that humans are terrible at predicting the future. The Federal Reserve is terrible. Their own economic forecast, and they're supposedly the best. Analysts don't do it well. Economists are terrible at it. Is there something inherently unknowable about the future, even the near-term future,

even a future a year from now. That's kind of what I take away from all of this, with 20 years of reading all your research and all everybody else's research in general. I think it was Philip Tetlock who did the book about how bad, general, people aren't forecasting anything, not just even economics or the weather.

Forget about it. There seem to be something inherently unknowable that's difficult to forecast about the future. Oh, okay. You're making a philosophical point, and I guess I would agree with it. It probably has something to do with entropy in the universe.

Eventually, our Nobel Prize winner Roger Penrose this year is talking about a day that will come when everything is scattered meaninglessly, everything is forgotten. You've got a number of billion years left to think about that. Yes, I think there is some fundamental underlying principle. But that doesn't mean

that we can't forecast in the short run. An analysis of both weather forecasters and economic forecasters is they can forecast out a short time. It's just not long enough. It's not comparable to your lifetime. And there are little things you can do to forecast a little bit. And so you can pay attention to those things and not worry too much. Let me just move on. Two more quick questions. One of my favorite chapters of your irrational exuberance when you talked about the press and specifically the financial press. And the implication was that I'm paraphrasing was that the financial press is somewhat complicit in helping put together these

narratives, for example, of what the stock market is doing on any one day, when in fact, it's characterized by drift, the random walk, as Burton Malkiel would say. Has the financial press gotten any better? I'm talking about, by the way, I am the financial press. Or are we still sort of complicit in putting together these narratives that don't really make any long-term sense? I think that the, yeah, you are in a competitive industry, as you must know, there are competitors. And you, people are drawn to news stories that are colorful, dramatic. So there is a tendency to over-dramatize a little bit, to emphasize things like anniversaries of events or as if that, mattered. Maybe it does matter if you follow them as a guide to what we should be talking

about. But I have a certain admiration. I'm outside the financial press. I have a certain admiration for them. They do have a set of their ears are open to a wide variety of facts. So I think the the financial press does have a warm spot in my heart. even though they may sometimes create bubbles. Yeah. Well, I appreciate that. Final question. I wanted to ask you about what the current state

of the efficient market hypothesis debate was. I don't want to get into anything long and scholarly, but I had Burton Malkiel on last week. Now, as I recall, you gave your noble lecture on the subject claiming that, I don't know, it was fallacious is too strong a word, but you didn't agree with it. Bert Malkia was on last week.

I've known him for many, many years, and he defended it again. He said that all the theory says is that asset prices reflect all the available information. It doesn't necessarily mean that the prices are right. He sort of hedged a little bit there. Is there any agreement on efficient market hypothesis at this point? Well, I have two things I have said about it a long time. 25 years ago, I once said the efficient market hypothesis is one of the greatest errors in the history of economic thought.

That was my mood. Since then, I've gotten a little bit more charitable, and I'm inclined to say that the efficient markets hypothesis is a half-truth. I have to first teach it to my student. I have an online course, by the way, you can take financial markets on Coursera. It's free. Okay. But I teach my students about the efficient markets hypothesis, because they probably underestimate

how efficient the market is and how difficult. it is to forecast. But then I unteach it a little bit, and I say that it's not, that doesn't mean the market is right all the time. And in fact, people who work on trying to predict the market are somewhat successful, especially if they're smart, and also I said hardworking. There's literature showing this. And so maybe you don't want to do it. Maybe your talents, maybe you'd like to be a physicist or a microbiologist or an artist. What do you need all this money for? But if you really want to, I think you can somewhat, on the average, beat the market.

It's an interesting point. Someday we're going to get back to it. I don't want to get into it too long right now, but I really do appreciate you taking the time out. It's, you've been a tremendous influence on me in the last 20 years, 25 years as the stocks correspondent for CNBC, and we really appreciate all of your work and all of your other colleagues who've done such groundbreaking work in behavioral economics in general. Professor Robert Schiller from Yale University, Nobel Prize winner, has been our guest today on the ETF Edge podcast. Professor, thanks very much for joining us. And everybody, have a healthy, happy and safe trading week.