Shiller on a US share market crash
Professor Shiller’s Crash Confidence Index measures responses from both institutional and individual investors in the US to the question: “What do you think is the probability of a catastrophic stock market crash in the US, like that of October 28, 1929 or October 19, 1987, in the next six months, including the case that a crash occurred in the other countries and spreads to the US?”.
The index for individual investors currently stands at 24.49, the lowest level since February 2013. In May 2017 it stood at 35.07, a two-year high – but has come down ever since, suggesting investors are less worried about a crash before this year is out. Institutional investors seem less sanguine, with that index at 30.22. That, too, however, has come down in the past 12 months or so – it stood at 38.22 in July 2017.
Professor Shiller, though, cautions that reality can be inverse to the index, as high investor confidence often precedes a crash. The crash index, which has been running since 1989, reached its highest level of 48.61 for individuals; 57.95 for institutional, in April 2006. The S&P 500 continued to climb higher, rising 20% more over the next six months. The stock market slump finally began in mid-September 2008, when the index had slipped to 25.82. “So it’s not like people know the future, they get it backwards,” says Professor Shiller.
Professor Shiller notes that the 1929 crash, which saw the Dow Jones Industrial Average lose almost 90% of its value in the intervening three years, was not expected. “There was no reason to say that this was going to happen. It wasn’t in any leading indicator that was around then,” he says. The only thing that had been giving instability to markets was the boom in margin credit – where investors borrow cash in order to invest at the margin. That had been happening because many investors saw the stock market as a one-way bet.
Of course, the last recession was caused by a housing bubble in the US, which led to a crisis in the sub-prime mortgage market. Professor Shiller called the top in the residential housing market back in 2008 (BB: He actually called it in 2006, before house prices started falling), with the S&P/Case-Shiller Home Price index reaching a peak in early 2006 before falling almost a third over the next two years. The index then moved sideways for a few years, but has been moving ominously upwards ever since 2012, “initially at 10% per year, now more like 5-6% per year”. In early 2018 it surged past the 2012 high. While Professor Shiller admits that is very strong growth, it is not the strongest. He notes that “Vancouver has been crazier, and Australia, New Zealand, Hong Kong, Shanghai”.
Professor Artus believes the residential property market is actually very robust today, with plenty of regulatory changes implemented in the years since the financial crisis. However, one area for concern could be US commercial property. “Commercial property prices are increasingly extremely fast, 8-9% per year,” he says. “And commercial property is not that sufficiently monitored. In the US you have something looking very much like a bubble.”
It is interesting that Professor Robert Shiller identifying MARGIN CREDIT as being the only thing that was forearning of a US share market crash in 1929. Of course, if Shiller's cyclically-adjusted price/earnings data had existed at that time, you woudl have seen that measure warning of the risk of a share market crash .... But let us focus on Margin Debt in the USA.
As you can see, there is a very strong correlation between margin debt andthe S&P500, with margin debt peaking with the S&P500 in both 2000 and 2007..... and now margin debt is at an even greater extreme.
Of course, Professor Robert Shiller's cyclically-adjusted price/earnings chart is also showing an extreme peak.