Bears warn that the market still has room to drop

Robert J. Shiller's view of the stock market gives investors and Wall Street the chills.

It's not just that the Yale University economist is a longtime grizzly bear on stock prices. (He growled loudly last year in his book, "Irrational Exuberance" - just about the time that high-tech stocks collapsed.)

It's that Professor Shiller remains bearish. "The stock market isn't as overpriced as a year ago. But it still looks kind of pricey," he says.

Moreover, the respected academic expert has rational reasons for his market melancholy. Looking at many decades of stock-market history, the average price of the Standard & Poor's 500 Index has been 13.5 to 14 times the earnings of the companies in that index. The S&P price-earnings ratio today is about 22 - still well above the average. And every day brings new reports of disappointing earnings as the economy slows.

Though noting the difficulty of short-term market forecasts, Shiller sees the possibility of further price declines - or of the market stagnating for a decade.

For the price-earnings ratio to return to its historic average level, the S&P 500 index would have to plunge to 560, almost half of where it now stands.

Wall Street analysts generally like to put on a smiley face when forecasting the market. Optimism sells stocks better than pessimism. And a bear market usually means huge layoffs by investment firms as commissions and profits tumble.

Shiller isn't entirely alone in his gloom. But such a view does not win friends on Wall Street.

"In my private life, I've become something of a social pariah," complains Stephen Roach, chief economist of Morgan Stanley, a major Wall Street firm, and a market bear. "Conversations stop dead when I walk into rooms filled with idle chatter." Mr. Roach sees a "a lengthy workout from the popping of the greatest financial bubble in modern history."

So does Wall Street economist Robert Parks. He points to a legacy from the "runaway boom" of "overcapacity, a pileup of inventories, towering debt now signaling a wave of corporate bankruptcies, skidding prices of high-tech goods, and plunging earnings." Plus an overpriced stock market.

Mr. Parks criticizes the Bush administration for its "long-run-supply-side-trickle-down-tax giveaway to the wealthy." What is needed are quick tax cuts that help lower-income groups lift consumption, along with sufficient new money, he argues.

"Bushnomic policy paralysis risks a deepening and prolonged recession," Parks holds.

Apparently that's not how the Federal Reserve sees it. Two presidents of regional Fed branches last week said the nation was not in recession. And their remarks were generally upbeat.

"If we are not at the bottom, we may be close to the bottom," Atlanta Fed President Jack Guynn told the press.

An economic recovery, however, would not guarantee the return of a bull market in stocks.

Indeed, Shiller suspects that stock investors, instead of enjoying the fabulous returns of recent years, may face a decade of meager profits. "We have had meager decades before."

Most economists figure the present record expansion lasted to March, making it 10 years old. The second-longest economic expansion lasted from 1961 to 1969, during the Vietnam War. Corporate earnings grew rapidly. Stocks soared.

But once the economy soured, real corporate earnings - after taking out inflation - did not return to their 1969 level until 1994, says Shiller.

Shiller wonders if the corporate-earnings boom of recent years has been inflated. Corporate executives had strong incentives in the way of stock options and bonuses based on earnings growth to pump up profits.

Employees too, he suspects, were caught up in the gold-rush mentality, expecting riches, working hard, boosting productivity.

"Now that is fading," he says. "We are not so exuberant." Shiller again refers to the "irrational exuberance" phrase applied to stocks in a 1996 speech by Fed Chairman Alan Greenspan. "If I'm right, earnings have been exaggerated," he says. "They may fall, too."

Most of Wall Street is counting on stocks bouncing back quickly, as they did after the 1987 market crash. But Shiller regards that as "an anomaly." The market was not so overpriced as today.

After the 1929 stock-market crash, markets came back somewhat briefly. But prices were down 34 percent a year later and 80 percent when they hit bottom in 1932.

Again, stocks peaked in 1989. And they stayed down, not recovering until 1992, Shiller adds.

"It takes time for a market to correct itself," he says. "It requires a fundamental change in people's thinking."

So where's a refuge?

Federal I Bonds offering 3.5 percent plus inflation (www. Treasurydirect.gov), suggests Shiller. Real Estate Investment Trusts also "look attractive," he says.

(c) Copyright 2001. The Christian Science Monitor