In a soon-to-appear book, “Phishing for Phools: The Economics of Manipulation and Deception” (Princeton University Press), that I wrote with George Akerlof of Georgetown University, we argue that the proliferation of such stories is a natural part of economic equilibrium. Successful people who value their careers rely on an instinctive sense for what pitch will sell. Who knows what the truth is, anyway?
As time goes on, the stories justifying investor optimism become increasingly shopworn and criticized, and people find themselves doubting them more and more. Even though people are asking themselves if prices are too high, they are slow to take action to sell. When prices make a sudden drop, as they did in recent days, people tend to become fearful, even if there is a subsequent rebound. With the drop they suddenly realize that their views might be shared by other people, and start looking for information that might confirm their belief. Some are driven to sell immediately. Others are slower, but they are all similarly motivated. The result is an irregular but large stock market decline over a year or more.
Recently, people have started to wonder if the market is too high. Since 1989, I’ve conducted surveys of both individual and institutional investors. I ask respondents whether the stock market is overpriced, underpriced or about right. Our valuation confidence index is the percent of those investors who think the stock market is not overpriced — that is, who think it is fairly valued or undervalued. Though this index charts only six-month averages, it is noteworthy that it has been dropping over the last few years, to the lowest level since just before the stock market crash of 2000. Though it is not quite as low as at that time, it is lower than at the market peak in 2007.