INTRO

What are the three roles that Shilling

played?
Eyewitness to history
Participant in the drama:
chronicler and prophet
Successful Forecaster

When is a speculative market peak
formed?
-When everyone who can be sucked in
has been sucked in

CHAPTER 1

Why do Bubbles last longer than
expected?
- They enter a realm of
Irrationality that knows no
bounds

What was his 2006 prediction?
- Mounting evidence of Housing
Bubbles demise
- 20% decline in prices
worldwide = optimistic
- Effect: Detrimental to
earnings/stock prices of
homebuilders, producers,
mortgage/subprime lenders/
Fannie Mae & Freddie Mac
- Why: Loose Lending Practices,
Low Interest Rates,
Securitization of Mortgages,
and expectations of Rising
House Prices

What are the requisites of a great
call?
It has to be important: far-
reaching w/ deep implications
(sample: 1973 massive
inventory-building)
It has to be nonconsensus:
Usually derided, bucked by the
majority
It must unfold for the
reasons stipulated a head of
time by the caller: Not from
dumb luck.
o Sample: 2007 Call re:
Collapse of Adjustable Rate
Mortgages
Others: When rates
reset to higher levels
than mortgagors could
afford little effect
because of dramatic
drop in short term
interest rates (more
borrowing)
Shiller: Declining house
prices would wipe out
the slender equity of
marginal homeowners

When was the US Recession
officially called?
- November 2008 (a year after it
started)

Who called it?
- Biz Cycle Dating Committee of
the National Bureau of Econ
Research

What are Shillers Fundamental
Principles in forecasting?
Human nature changes very
slowly over time
o Relevance of history
o Fore casting is an art


**************************************

On Hand to Mouth Buying
Why H2M Buying?
- Milieu: Traumatic events re:
Am Goods production &
distribution in 1919-1921
- Definition: The purchase of
only those inventories needed
to meet immediate customer
demand


What were the fears of the era?
- (1) Cancellation of govt
contracts for mil. Equip AND
(2) unemployment among
returning soldiers
depression!

Did it happen?
- Nope! (1) Exports leaped, (2)
credit expanded and (3)
demand surged
- Demand soaked up excess
capacity & Prices leaped

What were the effects of the above?
- Fear of shortages of raw
materials led to ordering of
more goods (i.e. JUMP OF
INVENTORY LEVELS)
- Created excess demand &
artificial shortages.
- Expectations: inflation
caused buying in anticipation
of rising prices (customers)

The Fall
- +24% in 1Q 1919 and peaked
in 2Q 1920
- 1920: Bubble broke and prices
began to fall (-42%)

What were the effects?
Order cancellations spiraled
Retailer side: Stuck with goods
bought at much higher prices.
Slashed prices
Consumer side: Curtailed
spending w/ deflationary
expectations held off buying

What was the end result?
Massive inventory-building
massive production cuts
Why? To liquidate inventories
Steepest Economic Decline of
any recession (Real GDP decline
of 13%)

**************************************
OK Back to the 1970s
**************************************

What was the milieu?
- Raging inflation due to excess
demand from govt spending
on Vietnam War & Great
Society programs
- Shortages in commodities
and manufactured goods

What was Shiller thinking?
- Why steel production was so
strong?!
- Much more steel was being
produced than consumed in the
early 1970s (NOT REPORTED!)
- Fears of shortages
double/triple ordering of
goods and understating
inventories to get prime slots
in allocation schedules

So what was the call?
- Rapid inventory building will
lead to an inventory correction
in 1975 and a recession
- Success!

What does making money from
bursting bubbles involve?
- Selling short

Why are short sellers important to
market stability?
- They keep markets from
jumping in unsustainable ways.
- Sometimes ferret out fraud and
unrealistic earnings
- Provide the other side of
hedges

Why is short selling expensive tho?
- Unleveraged short position can
make at most 100% of the
price if shortened security
drops to zero
- BUT loss is unlimited if price
rises and investor fails to cover
short positions

Development of rules on short
selling:
1929: Shorting stocks prohibited
except on the uptick (price of the
most recent sale of a stock had to
be higher than the immediately
preceding sale)
2007: Rule eliminated by SEC
2008: Reinstated due to
crumbling stocks
2010: SEC renewed curbs on short
selling

What was the effect of rising
inflation in the late 1960s and
1970s?
Pushed up interest rates
Drove down bond prices
Pushed real Treasury bond yields
into negative territory
Stock P/E were knocked down by
rising interest rates
1968 -1982: Nominal growth was
4% while real terms plummeted
64%

What was the consensus?
- High inflation would persist if
not increase. They were very
negative on stocks/bonds
(s&b)

What was Shillers Forecast then??!
- Inflation would unwind,
resulting in strength for s&b
- Why? Falling inflation rates
would push interest rates
down and T-bond prices up!
- Falling interest rates would
move P/E ratios up and
inflation would diminish
transfer of corporate
profitability to employees and
govt.
- RESULT: WELL HE WAS RIGHT

**************************************
Are bubbles new?
**************************************

NO! Theyve existed throughout
history and they always have an
underlying grain of truth.

First Case: On the Tulip Bubble
(1600)
- Introduced to No. Europe from
Asia in 1500s
- Branded as Tulipomania!
- Extremely profitable and high
demand!
- What? People of all grades
converted their property into
cash, and invested it in flowers.

Tipping point:
- Rich peeps no longer bought
flowers to keep in gardens but
to cell at a Cent per Cent profit.
- Result: Prices fell and never
rose! Universal panic upon
dealers

2
nd
Case: On the South Sea Bubble
(1700)
- SSCo was formed in England
and granted a monopoly on
Lat-Am trade in return for
taking on govt debt.
- Kernel: Idea of trading English-
manufactured goods for Lat-
Am G&S
- Problem: Lat-Am trade
controlled by the Spaniards
and Philip V had no intentions
of opening trade.
- What? People bought shares
with abandon! Stock leaped by
1000% in a span of 8 months.
More stocked was issued with
delayed payment to provide
leverage for speculators.
- Result: Collapsed!

What was so fascinating about this?
- The wide variety of speculative
public companies that formed
as the speculative fever spread
- Ludicrous Samples: Wheel of
perpetual motion, Company for
carrying out an undertaking of
great advantage, but nobody to
know what it is
- Govt became worried and
dissolved all these companies.

**************************************
What were the similarities between
Tulipomania and South Sea bubble?
(1) Limited substance
(2) Expanded too soon
(3) Burst before promises were
achieved

*Bubbles feed on the widespread
conviction that they will last
indefinitely
** only 2/3 of bubbles end in
crashes

Other samples: UK Railroads (Burst in
1840), US Railroads (Burst in 1873)
**************************************

On the Nifty Fifty (1970s)

What are they
- Represented rapidly growing
companies (some long term,
some fads)
- One Decision stocks BUY!
Because they will never need to
be sold
- Result: Fail!

What Shiller said:
- Emphasis was not on the basic
structure of the economy but
on frivolous enterprises.
- Predicted the 1973-1975
recession

On possible future bubbles
- Investment money is raising
concerns about asset price
bubbles in Asian Stock Markets
- IMF cites a risk that leaping
asset prices in HK are being
propelled by a surge of funds
divorced from fundamental
forces of supply and demand

**************************************
The Anatomy of Bubbles
**************************************
When do bubbles develop?
- In periods of financial and
economic tranquility after
memories of the last bubbles
collapse have faded

Minskys Financial Instability
Hypothesis: Eras of stability spawn
big risk taking

Samples:
Late 1920s: after rapid growth
between 1921 and 1929
DotCom: After 2 decades of
declining inflation rates and rapid
productivity growth
Housing Collapse: Moderation in
inflation/financial markets.

What are the similar steps that
bubbles have?

1. Investor Overenthusiasm
Attracts new entrants eager
to cash in on opportunities
to raise money cheaply,
accumulate wealth quickly
and participate in the
venture
Growth is robust and new
investment money is
plentiful such that costs are
of little concern
2. Competition
IPOs become prolific and
competition among
producers start to erode
selling prices.
Investors begin to have
doubts about its efficacy
3. Assurances from those with
vested interests
These come from all walks
of life!
Gives the example of ex-
Merrill Lynch CEO Mr.
Thain
4. As overenthusiastic
expectations are
disappointed, financing dries
up.
5. Followed by Bankrupcies
and consolidations
Companies/Investors w/
deep pockets are the ones
that ultimately survive

CHAPTER 2

************************************
GREAT CALL #1:
1969-1970 Recession
************************************

What were Shillers concerns?
- Rising inflation rates
- Why? Heavy govt spending on
Viet War and Great Society
programs (Guns&Butter policy)
caused Fed to raise federal
funds rate
- Guns and Butter?
Demonstrates the relationship
between a nations investment
in defense and civilian goods. A
nation has to choose between
guns (defense/military) or
butter (invest in production of
goods) or both!
- April 69 Forecast: Mild
recession for 1970
- Dec 69 Forecast: Major
recession!

Why is this major recession bullish?
- It would knock inflationary
psychology rising with inflation
(6% p.a.)
- If it was only a mild recession:
inflationary expectations
would be intact but price
acceleration might degenerate
into runaway inflation and
credit demand would outrun
any reasonable increase in
supply
- Did a recession occur? YES!
But not deep (GDP falling
0.6%)

Why was it a great call?
Rq1: No recessions since 60-61
downturn
Rq2: Forecasters saw no
recession in the offing
Rq3: He was right! Haha

What was the milieu at the time
anyway?
Rising stocks due to statements
that the Nixon admin wouldnt let
current fiscal/monetary restraints
push the economy into a recession
Few worried about detrimental
effects of stock price inflation
Common belief: Stocks were a
great offset to inflation and that
rising consumer prices might spur
equity prices

What were the variables to Shillers
statistical model for explaining
stock prices?
Money Supply
Biz Sales
Excess Capacity
Trends in Stocks
Inflation

What was his main takeaway?
- This recession wasnt deep
enough to curb inflationary
expectations and their
economic distortions avers
that this led to the inventory
buldge of the early 70s

**************************************
GREAT CALL #2:
1973-1975 Recession
**************************************

See Chapter 1 for inventory milieu

Why was it a great call?
Rq1: Shortages seen as artificial
and driven by a self-feeding
inventory-building binge as
inflationary expectations ruled.
Shiller said (1) it would be the
deepest recession since the 30s;
(2) there would be a decline in
stock prises; and (3) the demise of
the Nifty Fifty
Rq2: It was at variance with
almost everyone elses conviction.
Rq3: He was right! When excess
inventories were dumped in 4Q74
and 1Q75, real GDP fell 1.6% and
4.8% at annual rates.

**************************************
GREAT CALL #3:
Disinflation (late 70s)
**************************************

What was the milieu?
- Stagflation: Leaping inflation
co-existed w/ high
unemployment
- Frustrations over failed Viet
war and Water gate scandal
- Growing Fed Govt involvement
in the economy associated
with economic growth
- Conviction that the economy
was strong enough to fight a
war in Asia and embark on
massive domestic spending
w/o creating inflation &
other probs!

Over-reaching by policy makers:
- Thru fine tuning by policy
makers of fiscal/monetary
policy
- How did it go? DISASTROUS!
- Effect? Aggregate demand far
in excess of supply
INFLATION YO!
- Caused a shift in voter
sentiment

Why was it a great call?
Rq1: Shiller predicted that
inflation would wane and
disinflation would reign in the
years ahead over-all prices
will still rise but at slower and
slower rates . This was counter
the conviction that inflation
was a permanent fixture
Rq2: It was made well before
Fed hiked interest rates
massively. It was also not
accepted by many even as it
unfolded.
Rq3: He was right!

What is the prime mover behind
inflation?
What happened? Money supply
leaped at 26% annual rates and
CPI inflation +14% after
wartime wage/price controls
were removed
In reality: monetary policy
was the handmaiden of fiscal
policy.
o Meaning the govt didnt
wanna raise taxes to pay
for the leap in military
spending (40% of GDP)
so it relied on the FED
and bond sales to
finance the federal
deficit

**************************************
GREAT CALL #4:
1980s Japanese Bubble
**************************************

What was the milieu?
- Spectacular Post WW2 revival
of Japan
- Japanese economy developing
bubble dimensions w/ high and
rising levels of consumer
saving fueling stock and real
estate booms + industrial
capacities
- P/Es of 100 were
commonplace and value of all
Jap equity markets > total US
stocks even if Jap economy was
only of US.
- People worried about take-
over from Japanese businesses

Why was it a great call?
Rq1: Few others expected the Jap
bubble to burst. Shiller said that it
was in the latter stages of a bubble
and forecasted an imminent end
Rq2: Nobody saw it coming
Rq3: He was right! Japanese
Central bank (Masushi Mieno)
began to raise interest rates which
broke the stock and real estate
bubbles. Nkkei fell 81.9% to a low
of 7055 in 2009. Real Estate fell
90% or more.


**************************************
GREAT CALL #5:
Dot-Com Blow-Off
**************************************

What was the milieu?
- Late 90s: US economy and
stock market humming ince
1982
- Receding inflation
- Highlighted by corporate
restructuring (C.R.) of Am
businesses and decline in
defense spending
- (C.R.) paved the way for rise of
new technologies which drove
economy and unleashed
productivity potential
- Result: Mushrooming
corporate earnings

So what if there was rising
earnings?
- Investors convinced that there
was faster growth
- Falling inflation/interest rates
pushed P/E ratios through the
roof

What were the effects of intense
speculation at the time?
- Investors counted on market
advances continuing
indefinitely (+20% p.a.)
- Savings rate plummeted
- Favoring companies w/o
dividents (div yields down to
1%)
- Stock market directing the
economy vs. other economic
conditions
- The surging stocks drove
consumer spending
- Whats new? Tech companies
IPO-ing at 100x sales w/o
earnings (high valuation even
w/ great losses)

How did the Fed react to this
looming problem?
- June 1999: credit was
tightened and yield curve was
inverted
- Greenspan makes irrational
exuberant speech to no avail

What were the 20 follies:
Irrational Exuberance: Stocks
will leap indefinitely because corp
earnings will grow faster than
economy and P/E ratios will rise
forever in the New Economy
world
Buy&Hold: W/ a continuous bull
market, investors should buy and
hold
Buy in Dips: Dips are
opportunities to buy, not
warnings to get out of stocks
No Appreciation for past
market data: thinking that pre
82 mkt data was irrelevant
Investment Allocation: invest x
% in small-cap value stocks and y
% in big-cap growth stocks
Cash is trash: they represent lost
investment opportunities
Beating Benchmarks > Absolute
Returns
Index Investing > Active Stock
Mgt
Invest in Sector index funds to
cash in on new tech
Indiv investors can beat the
pros yo
Day trading = easy route to
riches
Investment gains > Investment
fees
Pro-forma results > GAAP
numbers
Stock buybacks as beneficial to
stock prices
AVOID DIVIDENDS
T-bonds for wimps
Detained pension plan profits
steady source of pre-tax corp
earnings
Investing Social Security
contributions in stocks = solves
post-war retirement prob
IN THIS NEW ECONOMY, THIS
TIME IS DIFFERENT, MAN

What was the call?
- 2 years before the collapse
- P/E Ratios at Nosebleed
altitudes
- Rate hikes by Fed were in store
- Bear market would come in a
long & frustrated saw-tooth
pattern along a declining
thread
- It would:
o Slash NASDAQ (70-80%)
o Slash S&P500 (40-50%)
o Slash Dow Jones (30-40%)
- Reasoning: most of these
companies have no earnings
and w/ little prospect of
making money

What are the ways new tech kills
itself?
- Overinvestment
- Excess Capacity
- Excruciating Competition
- Commoditization of products

Did CFOs believe that the stocks
were overpriced?
- Hell no! 82% said they were
UNDERPRICED!

The actual bursting:
- Investors continued to buy as
the bubble expanded.
- Problem: Stock value
measured by sales forecasts
vs. earnings.
- Rise of shady practices

What is spinning?
- Underwriters awarding hot
IPOs to tech industry
executives in return for
investment banking business
- Repay 50% and then 65% of
the resulting 1
st
day profit in
commissions

What was Shillers case for a full-
blown recession?
Feds rate hikes in previous 18
months
Inverted yield curve
Continued vulnerability of stocks
Negative effect of continuing high
energy prices
Similarity between 00 US
economy and its structure at early
biz cycle peaks
Prolong resolution of pres
election and 50-50 split in
Congress that would
weaken/delay fiscal stimulus to
revive economy

What was the aftermath?
- Investors: Soft=landing for the
economy!
- Shiller: There are rallies but
they are brief and temporary
- Investors: Sky isnt falling
- Shiller: Diversify portfolios!
Global diversification
reduces volatility of
stock/bond portfolio

What is the behavior in periods of
high volatility?
- US and foreign stocks march in
lockstep
- And when Americans are losing
money they sell foreign
holdings first

Reasons for Global Stock weakness
- Global economic softness (due
to universal CB tightening)
- Growth of foreign countries
dependent on exports
directly/indirectly bought by
US consumers
- US recession global
recession

Why is it a great call?
Rq1: It was important in the
sense that it exposed the feeble
milieu of tech stocks at the time
Rq2: Clearly everyone thought
otherwise about tech stocks
(irrationally exuberant)
Rq3: He was right! The DOW
JONES, NASDAQ, and S&P went
down in the manner described
and were close to his forecast.