Sunday, January 30, 2011

Irrational Exuberance: Chapter 4

In the year 2000, while many market pundits expected the market to rise continuously upward, Robert Shiller warned about the stock market bubble, though not that many paid attention. While most were blinded by optimism, Shiller demonstrated using fundamental analysis that the market would generate poor returns for years to come. Learning from and understanding Shiller's rational approach to market valuation is likely to aid the investor in avoiding falling prey to the bubbles of the present and future.

The media's role in the creation of the hi-tech stock bubble of the year 2000 is discussed in this chapter. Shiller points out that the history of speculative bubbles begins roughly with the advent of newspapers! While the media present themselves as detached observers of the stories they cover, they are a major player in these events.

Shiller argues that bubbles can only occur if there is similar thinking among large groups of people. The media helps make this happen. With everyone on the same page, markets are free to rise and/or fall by large amounts.

Shiller also takes issue with some of the media's explanations for market occurrences. For example, on a given day the financial media always has an explanation ready for why the market fell or rose. But Shiller presents data that suggests these after-the-fact links are fallacious. He argues that when there is a big market event, though the media will emphasize some news item it has picked to be the cause of the event, it is actually the price change itself that is the news. Shiller takes the reader through news items preceding the 1929 and 1987 crashes, demonstrating that nothing out-of-the-ordinary was occurring in the news, though the media did attribute the causes of the crash to various current events of the time.

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