Online Extra: "The 20th Century Was Probably Lucky"

Robert Shiller, author Irrational Exuberance, says investors shouldn't expect a repeat performance in the 21st century

Robert J. Shiller wrote the book on investor folly. A finance professor at Yale University, Shiller thinks the stock market has entered a prolonged period of low returns and high risk. His opinions are not to be ignored: Shiller is the author of a best-seller about stock market excesses, Irrational Exuberance. In this book, he essentially predicted the market crash that happened just as it was published in early 2000.

Irrational Exuberance describes how shareholders get caught up in what Shiller describes as naturally occurring Ponzi schemes in which stock-issuing companies, Wall Street underwriters, the media, and investors combine their enthusiasm to carry share prices so high that they inevitably collapse.

Though Shiller doesn't think stocks always outperform other types of investments, he happens to be very good friends with Jeremy Siegal, a finance professor at the University of Pennsylvania's Wharton School. Siegal, author of the classic book, Stocks for the Long Run, published in 1994, argues the exact opposite viewpoint. BusinessWeek Associate Editor Marcia Vickers recently interviewed Shiller to get his thoughts on the market today and where it's heading. Following are edited excerpts of their conversation:

Q: Are investors still overconfident when it comes to the stock market?

A: It seems to me that confidence is declining. Investors are in the midst of learning a hard lesson that stocks may not always be the best investment and consistently outperform.

Although dwindling investor confidence occurs when a bubble deflates, it takes time. That's partly because people usually don't change their opinions by themselves, they have to realize others have changed, too. Let's say an investor is at a barbecue and three of his or her friends say they're fed up with the market and stock analysts -- that's when the investor really starts to rethink the market.

Still, people talk about capitulation all the time. I don't think we've reached it yet. Eighty percent of people are still certain that the market will go up this year. And nothing has replaced these stories that stocks are always the best invesment. Also, it's ironic, but as investor confidence dwindles, experts say that's all the more reason to invest. Analysts are putting out these optimistic forecasts. But at least investors are now saying "Show me, show me."

Q: Why is investor confidence so crucial to the market?

A: Countries which show a lot of mistrust tend to not do well economically. That's because trust facilitates business. But if there's no trust or little trust, people think, "What's in it for me?" and everything in the economy slows down. There was too much trust in late '90s, when folks didn't look too carefully at the business elite because they thought they were a bunch of geniuses who would make money for them. Trust has deteriorated in the last few years, and isn't likely to recover

soon.

Q: So "stocks for the long run" clearly isn't part of your repertoire?

A: I keep saying the 20th century was probably a lucky century, and investors shouldn't expect the 21st to do as well. People are overly impressed with history. There's no theory that the market has to do as well.

For one thing, there's the impact of globalization and technology. For example, China is marching ahead very fast and starting to compete with companies that don't have competition right now. Labor costs are very low in those countries, and they have smart people.

Q: What about the geopolitical tensions right now? What kind of impact do they have on the market?

A: The Iraq problem strikes me as different from the 1990-91 Gulf war. The stock market felt very little impact then because we weren't making an unprovoked attack on Muslim countries. There's a chance that terrorism may be bigger this time.

Q: So when will the stock market begin to recover? Never?

A: People have to be willing to throw away $100 on something with a sense things will come out well. But if there's little optimism, people aren't willing to do that. The psychological changes which happened in Japan [after its stock market crash in the late 1980s] could be happening here. And like in Japan, it could take a long time to shake out.

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