Monday, February 21, 2011

Irrational Exuberance: Chapter 11

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.

In this final chapter, Shiller warns of the dangers of ignoring the high price level of the market. While to the observer it may seem that all a stock market crash would do is bring prices back in line with where they were a few short years ago, Shiller notes that the losses would be particularly harsh on certain groups. For example, someone who invested early and has been selling will do just fine; but someone who invested all their money at the end of the bull market will face devastation.

Shiller discusses a few factors which could derail the market. Among them are the following (keep in mind that he wrote this in the year 2000):

- foreign competition
- an oil crisis
- newly discovered problems with the longer-run consequences of incentive-based compensation for employees
- a war
- a terrorist attack (this was written just a few months before 9/11)
- systemic problems due to a failure of major banks

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