Will The Dow Ever Hit 50,000?

By Robert Shiller; James Glassman; Kevin Hassett

It's totally logical, say economist Kevin Hassett and journalist James Glassman, who argue in Dow 36,000 that stocks are both safe and undervalued. Not so fast, says Yale economist Robert Shiller, whose Irrational Exuberance says the market is headed for decades of trouble. The two sides had it out in a TIME debate.

GLASSMAN Stocks have returned an annual average of more than 11% for the past 70 years. And, in fact, really for the past 200 years. I think that's enormously important for people to understand. It is a tremendous return compared with the alternative, bonds.

We say emphatically that stocks are undervalued today and that people could hold them and feel comfortable. You can use different assumptions and get a 55,000 Dow, but we are very comfortable with 36,000. And, in fact, most people don't have enough stocks in their portfolio.

You say exactly the opposite. You say people ought to dump the stocks that are in their portfolio because we are headed for a terrible crash, which is something you have been saying now for four years.

SHILLER I didn't say "terrible crash." That is one plausible scenario, but other plausible scenarios are that [the Dow] will go up for a while and then just kind of hover for many years and give a low return. My book uses a 10-year horizon, which is viewed as the really long term. Ten to 20 years, it looks like we will have poor runs, maybe in the negative for 20 years--there is a good chance of that. In periods of high P/Es [price-to-earnings ratios, a measure of how expensive stocks are], stocks have done poorly subsequently. Your argument is that people have learned something and that historical data are no longer relevant. But that is what the historical data say.

HASSETT There is no question that if you run through history, Bob is right--that over some periods following peaks in the P/E, there were some bad times. My problem with that exercise is that if you took anything, any metric of how the market is doing, and calculated the average over time, then, of course, when you are above it, then you go down, and when you are below it, you go up.

SHILLER Not necessarily, not with the P/E ratio. You are suggesting there is some spurious--some fallacy in that. There isn't a fallacy here. I look at past historical periods when we had similar leveling, and you know, what comes to mind is 1929. We have had a tripling of the stock market to a record high level in the past five years, and there is only one other time when that has happened, which was '24 to '29. So history doesn't encourage me to think people have suddenly learned something.

GLASSMAN I just think people should know that in 1990 the Dow was at 2,600. In 1995 it [finished] at 5,100. Now, if you are Bob, you would say, "Whoa, we are about to have another crash like 1929." What has it done since the end of 1995? We are now, as we sit here, above 11,000 [the Dow closed at 10,609 last week], so I don't think it is predictive to say simply that if the Dow triples, it is going to crash. In the past 18 years, the Dow has risen by a factor of 14. What we're saying is that something profound is going on.

SHILLER We agree on that.

GLASSMAN O.K., something is changing. What is changing is that people are at last beginning to act in a rational way. They are bidding up the prices of stocks because, my gosh, stocks in the long term are no riskier than bonds...They have learned something about stocks, which I think Bob would admit and we certainly believe is true. For all these years, they have acted in a kind of irrational way. Now they have learned something, which happens to be true, which is that in the long term, stocks are not all that volatile, and they return more than bonds.

SHILLER People believe stocks are safe. But I don't think this represents learning. It suggests this is what we call a speculative bubble. When stock prices go up--and they have been consistently for a while--people get a feeling that they must go up. So to me it is very clear what has been happening in recent years. It is not like people have just taken a course in economics and were impressed with the data. That is not what happened. We have seen so many cases in history of speculative bubbles. And we should learn now to recognize their elements. The essential element is that there is a "new-era theory," which becomes promulgated more if there are also stock-market price increases.

HASSETT No. People have learned the right strategy. They have learned to buy and hold for the long term.

SHILLER See, [your] book title, if you look at it, it says, The New Strategy for Profiting from the Coming Rise in the Stock Market. You are selling books by telling people the risk premium is going to go to zero in three to five years. And you present no evidence for that.

HASSETT The equity risk premium has declined. Let's define this, by the way. Equity risk premium is the extra return that investors demand because they think stocks are riskier than the benchmark [30-year Treasury] bond. O.K., it has declined roughly from 7% to 3%. [A decline drives up prices.] Alan Greenspan says, "The question is, Is this decline temporary or is it permanent?" We offer a third alternative we think is a reasonable alternative, which is, Will it continue [to decline] to what we believe to be its reasonable resting place, which is around zero? If stocks and bonds are equally risky over the long term, there should be no equity risk premium. It should be close to zero.

SHILLER It is not reasonable that the risk premium should be zero. You can buy inflation indexed bonds at 4% [risk free]. That's why I am a big advocate of index bonds. It is one of my campaigns.

HASSETT I took a huge loss on my index bonds. I bought them like three or four years ago, and the rate was down like 12%.

SHILLER That's short term.

HASSETT But what you are saying is that those index bonds are not risky if you hold them for 30 years. Well, that's true for stocks.

SHILLER But consider one 20-year period, which was '29 to '49, [the return] was just about zero. If you look at a broad indication of the world and history, it has been at times very risky, and it certainly has the potential to be risky in the next century, which is the future. Not the past.

GLASSMAN We say stocks will become fully valued at roughly 36,000, and then, as Kevin says, returns will trail off after that, when they are truly fully valued. So I think that is important for people to remember. If we are wrong about the lump sum up front, then maybe what will happen will be it will continue the way it has been over the past 70 years. At any rate, 11% is a lot better return than 5.5%.

Robert Shiller is a professor of economics at Yale. James Glassman and Kevin Hassett are resident scholars at the American Enterprise Institute