Irrational Exuberance…Again?

Are we still irrationally exuberant?

One of the most important lessons you can ever learn about markets is also one of the easiest to forget: Just because prices are more reasonable than they were doesn't mean they're reasonable. I'm sorry to report that it's absolutely the lesson to keep in mind now that the Dow has hit 42-year highs and crept back up near 11,000.

The preeminent teacher of that lesson is rob_businessert Shiller, a Yale professor with a strong record of thinking independently and being right. His book Irrational Exuberance, arguing that stock prices were insanely high, appeared almost precisely at their peak in March 2000. Now he has updated the book to reflect 2005 valuations and concludes that, believe it or not, the market is still irrationally exuberant.

How can this be? In part, it's due to a new generation of investors. People like me came of investing age in a time when stocks only went up. But…

As Shiller points out with voluminous support, it just isn't true that stocks always outperform other investments over long-term periods, and, he says, "there is certainly no reason to think they must in the future." If that's true, then stocks would appear to be just as risky as ever. We are not in a "new era." Math still works the same way. And today's valuations are too high.

What Shiller forgets is that people don't know math, and don't care about it. My anecdotal experience would tell me that about 80% of the people I know believe that it's possible to consistently come out ahead by gambling. And about 80% of those people believe they are net ahead for their lifetime.