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


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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)
Age of Deleveraging
Chapter Summaries
- 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

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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.