Roger Shiller's Advice: "Stay Away from the Pack"

Money Magazine's Jason Zweig Interviews Robert Shiller

Readers of this blog know that I hold Robert Shiller in high esteem. He is, after all, the man who warned us all that the Internet stock mania would end badly. In fact, his book which clearly outlined this warning, "Irrational Exuberance", became the most famous two words uttered by ex-Fed chief, Alan Greespan, when he warned Congress the markets were valued way beyond sanity.

In an earlier blog of mine "How Stocks Have Done Since the Millenium: Why Buying My Rental House is a Losing Bet Today", I quoted from an early article by Shiller published on the Internet in 2005 which warned that Housing would crash as surely as the Nasdaq crashed in 2000.

I quoted from Shiller's article the last two paragraphs verbatim:

"Well, we are looking upon a real estate boom again, and we are likely to observe the same end to speculative feeling, at least before many years have passed. Human nature is unchanged. In a bubble, high prices are sustained only by the expectation of more high prices. That is what makes a bubble a bubble, prone to bursting.

The reason we cannot expect a soft landing today is that right now people are willing to pay these very high prices only because they expect them to go up even more in the future. Prices can't just level off, because when people no longer expect them to go up, some of them will not want to hold at the high price."

Yesterday, a new interview with Shiller appeared on the Internet titled "Robert Shiller: Mr. Worst-case scenario." The interview was conducted by Money Magazine's Jason Zweig, placed on Yahoo Finance, and I've cut just the interview from the piece for your reading pleasure:

Question: What caused the stock bubble, and why did it end as it did?

Answer: Some sociologists talk about collective consciousness. We humans evolved to be very closely linked, and our minds focus on the same ideas. Those [ideas] get reinforced because we hear them all the time.

Back in the late 1990s, you kept hearing that you had to stake your claim on the Internet or you'd miss out on the future. No one cared about the present.

Then something happened around March 2000. There was an acceleration of public talk about doubts. You could no longer declare at a cocktail party that Internet stocks were going up. Such statements had become embarrassing -and just like that, word of mouth changed. Embarrassment is a powerful emotion.

Question: Is that about to happen in real estate?

Answer: It doesn't seem like we're there quite yet. But this is the biggest boom in housing prices since, well, ever.

Nothing seems to explain it, and nobody forecast it. It seems to me...wait a minute. Please don't quote me as forecasting the markets.

Question: Okay. What you're about to say is not a forecast.

Answer: Well, human thinking is built around stories, and the story that has sustained the housing boom is that homes are like stocks. Buy one anywhere and it'll go up. It's the easiest way to get rich.

Question: So how rich can you get on real estate?

Answer: From 1890 through 1990, the return on residential real estate was just about zero after inflation.

Question: Excuse me? That's all? Hasn't it been higher lately?

Answer: Since 1987 it's been 6 percent [or about 3 percent a year after inflation].

Question: So real estate doesn't go up roughly 10 percent a year?

Answer: It can't be true that homes rise 10 percent a year. If they did, in the long run no one would be able to afford a house.

Question: Let me grab a calculator. If real estate really rose 10 percent a year, a $25,000 home in 1957 should be worth roughly $3 million now.

Answer: And that flies in the face of common sense. In fact, I'm inclined to think there's a good chance that the return on real estate will be negative, substantially negative, over the next 10 years because all booms reverse in the end.

Question: All right. We won't call that a forecast either. So how should people think about their home as an asset?

Answer: Avoid concentration of risks. You need a house, but I would avoid a second one - or at least avoid an outsize house. Over-investing in real estate now would be a recipe for disaster.

Question: You also write about the risk to human
capital. What's that?

Answer: What you're trying to do is to invest in skills that somebody else will want to pay you for. Let's say you want to work at Bethlehem Steel.

That would have been a good idea in the 1950s, not so good by the 1970s. The world went the wrong way on you.

Question: How can you manage that risk?

Answer: I used to coach children's soccer, and I would tell my players, "Stand away from the pack, and sooner or later the ball will come to you."

In your career choices too: Get away from the pack. Also, you associate your home country with safety. But the rest of the world is pretty peaceful too, on average, and the average is all that matters.

I think relatively few [Americans] are getting away from the pack, investing more outside the U.S. than in.

Question: How are you investing now?

Answer: I'm probably a little over 60 percent in stocks, almost all of it outside the U.S. I have a lot of cash. And I've been reducing my exposure to real estate. It may be at the end of a cycle.

Since the late 1990s, Blue Chip Big Caps have been ignored by investors. Big Caps have sorely underperformed Emerging Markets, small caps, Real Estate, and so on.

However, I firmly believe this is the time to be loading up on familiar Big Cap names with Global exposure. I especially urge anyone buying stock to focus on the following three top performing sectors since the beginning of the S&P 500 in 1957:

1. Energy
2. Personal Staples
3. Healthcare

I have two energy stocks I will be discussing on this board in the near future which I would urge anyone to buy, sock away in a Roth IRA or other retirement account, and re-invest the dividends forever until you are ready to retire.

I have two personal staples stocks I would recommend here and now.

I have two healthcare stocks I will recommend to anyone in the near future.

And I have one mid-cap stock which is a play off all three sectors and other stocks which have sustained growth while paying dividends.

I will be publishing my first official stocks picks soon on this board. And these picks will be looked at monthly on a Watchworld scorecard.

That said, Shiller is urging us to invest overseas. What Shiller did not bring out is this: you can buy multi-national companies which have large presences overseas.

In fact, four of the seven stocks above which I will soon recommend make more money overseas than they do in the USA . . . and I think when I mention some of these names . . . you will be stunned to learn that these "American" companies have larger exposure off-shore and are making big profits by currency exchanges added into the mix.

For now, however, go back and read what Shiller is telling anyone who is thinking about buying Real Estate in these exuberant times.

He believes:

• You know the Real Estate Bubble is finally dead when people are too embarrassed to talk about it openly as a way to make money. (You know we haven't reached that point in Key West as the local NAR branch is still running ads "Now Is a Great Time to Buy a Home!")
• From 1890 - 1990, the return on Real Estate was zero after inflation was factored in.
• From 1987 through 2007, Real Estate has only gone up roughly 6% annually. In reality, the reutrn is only 3% annually after inflation is figured in.
• Real estate could not possibly go up 10% a year as some NAR wags claim as that would make a house which cost $25,000 in 1957 worth $3 million today. (The house my parents bought for $7,000 in 1950 would not be worth $60,000 today in Richmond, VA . . . which means it doubled in price only three times in 57 years for only a 3.84% compounded annual growth rate . . . and this includes the last five to seven years of the Housing Bubble)
• Avoid concentrations of risk. Go where others are not already crowded.

p.s. Disclosure: I am very heavily weighted in gold, silver and oil in my real life portfolios. In fact, I own real gold and silver proof coins.

Anyone who does not own gold, silver and oil in their portfolios at this time in history is simply playing Russian Zip with an Uzi machine gun loaded with a full clip, IMO.

If you can't make yourself buy real gold and silver as a hedge, please, understand where oil is today with prices already skirting $4.00 a gallon in the Florida Keys.

Read the Mogambo Guru's weekly column you see headlined on the margin of this blog. His humorous writing is a compendium of knowledge he has gleaned from other writers during the past week. Mogambo is crazy as a fox. Read and learn.

You will also want to see a Matt Simmons slideshow about oil. Just google his name. Look for a slideshow. All you need to know about oil is right there in 50 or 60 slides that Matt has put together to wake you up.

Look about you. Start thinking about the obvious. See all those For Sale signs in your town? Who can afford to buy those homes now that the EZ Credit train has jumped the track leaving millions of bagholders on the platform scratching their asses wondering who is going to take them away from all the masses scratching their asses?

Keep reading this blog to learn that Real Estate has gone colder than Walt Disney's head.

Meanwhile, use your head.

Gold, silver, oil. Get those hedges first if you are just starting out. Then we can add in the healthcare and personal staple stocks later. As Mogambo would say, you can thank me later.