Irrational_Exuberance_Shiller - Study notes By Zhipeng Yan...

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Study notes By Zhipeng Yan Irrational Exuberance Robert J. Shiller One: The Stock Market Level in Historical Perspective 1. Price-earnings ratio, the real (inflation-corrected) S&P composite Index divided by the preceding ten-year moving average real earnings on the index. The ten- year average smoothes out such events as the temporary burst of earnings during World War I, the temporary decline in earnings during World War II, or the frequent boosts and declines that due to the business cycle. P7 2. high P/E ratios: June 1901=25.2 (Twentieth Century Peak); Sept 1929=32.6; Jan 1966=24.1 (Kennedy-Johnson Peak); Jan 2000=44.3 3. P/E ratios and Subsequent Long-term Returns: horizontal axis P/E for that month; vertical axis, the annualized real stock market return over the ten years following that month. They are negatively related. P12 4. The recent record-high P/E has been matched by record-low dividend yields. In Jan 2000, S&P dividends were 1.2% of price, far below the 4.7% that is the historical average. Dividends historically represent the dominant part the average return on stocks. The reliable return attributable to dividends, not the less predictable portion arising from capital gains, is the main reason why stocks have on average been such good investments historically. P13 5. Times of low dividends relative to stock price decreases (or smaller than usual increases) over long horizons, and so returns tend to double hit at such times. From both low dividend yields and price decreases. Two: Precipitating factors: The Internet, the baby boom, and other events 1. Internet : US corporate earnings growth in 1994, up 36% in real terms as measured by the S&P Composite real earnings, followed by real earnings growth of 8% in 1995 and 10% in 1996, coincided roughly with the Internet’s birth but in fact had little to do with the Internet. What matters for the boom, is not the reality of the Internet revolution, which is hard to discern, but rather the public impressions that the revolution creates. P21. [the theoretical effect of a sudden technological advance might be to spur investment in new capital, which will compete away any extra profits that the technological advance might generate for existing capital(P237)] 2. The decline of foreign economic rivals: the relation between US and its economic rivals is often described as a competition. The weakening of a rival is thus viewed as good news instead of as ominous developments for US stock market, as the harbinger of what bad things could happen here. Confidence in the premier capitalist system would translate into confidence in the market, and that the US stock market should be the most highly valued in the world. P21-22 3. Cultural changes favoring business success or the appearance thereof: the bull market has been accompanied by a significant rise in materialistic values; Firms have tilted their compensation packages for management away from fixed salaries toward participation, as investors, in the firm. By 1998, employee stock
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This note was uploaded on 03/18/2011 for the course ACCT 601 taught by Professor O'connel during the Spring '10 term at New York Institute of Technology-Westbury.

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Irrational_Exuberance_Shiller - Study notes By Zhipeng Yan...

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