The danger of a bear market.
Robert Shiller finds himself ending the decade in virtually the same conversation in which he started it.
In early 2000, the Yale University economics professor's soon-to-become hugely influential book, Irrational Exuberance, was about to hit bookshelves - illuminating the world on how market bubbles form and how they burst. The book essentially foretold the popping of the dot-com bubble only a few months later.
Now, in the aftermath of the second major stock market collapse in less than a decade, Mr. Shiller is again being asked to help explain why stocks have become so volatile.
His answers to these question may be even more pressing now than they were in 2000, as investors look back on a "Lost Decade" for North American equities.
After four 50-per-cent-plus moves (two down, two up) in less than 10 years, the S&P 500 ends the decade 24.1 per cent below where it started. The S&P/TSX composite, while faring generally better thanks to the surge in commodity prices, is nevertheless up a modest 39.6 per cent for the decade - less than 4 per cent annualized, and roughly one-third of its annual growth rate through the 1980s and 1990s.
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Now, with wary retail investors 10 years closer to retirement with little to show for it, they want to understand: What's gone wrong?
Mr. Shiller's less-than-comforting answer: We're mostly doing it to ourselves.
"I think it has to do with a different world view that we have adopted. We're much more of an investing culture, all over the world, really, than we were in the past. There's much more of an expectation of volatility."
Mr. Shiller says our mass psychology is much more one of speculation and risk-taking than it was a generation or two ago. We've come to rely on rising markets to create our wealth and well-being, at the expense of savings.
The result? An increasingly rapid succession of boom-and-bust markets, where an overexuberant herd mentality pushes asset prices to unsustainable limits until something bursts the bubble and we fall to Earth with a sickening thud.
And with more people participating in the markets than ever before, the impact becomes more pronounced each time the mass of expectations shifts from confidence to doubt, and back again.
"People used to look at dividends more than they do now," he says. "As the years go by, people are more and more focused on capital gains. So it has become more of a game of predicting the swings. And when you have everyone trying to predict the swings - and the swings are caused by people anyway - it creates a fundamental instability."
Mr. Shiller's focus on the shifting psychology of market participants may seem a bit too fuzzy for investors seeking more concrete causes for the market's mood swings of the past decade. Yet it's hard to dismiss, given Mr. Shiller's enviable track record for identifying bubble mentalities.
Not only did he call the bursting of the dot-com bubble, but a second edition of Irrational Exuberance , published in 2005, warned of continued overheating of the stock market and predicted the bursting of the dangerously bloated housing market.
Still, others point to less esoteric causes for the Lost Decade. The culprit they often identify is debt - the overreliance on borrowed money, made easy by low interest rates, to finance not just investing, but consumers and governments.
Marc Faber, the famed contrarian investment adviser known as "Doctor Doom" for making bearish calls on overinflated markets at various times during the past three decades, argued in a recent report that persistent low-interest-rate policies by central banks have perpetuated boom-and-bust market cycles, because they encourage excessive borrowing and risk-raking that push asset values beyond what their fundamentals can justify. And he worries that the central banks are starting the cycle again with their aggressive liquidity measures.
"In the process of combatting consumer price declines, these economists and bureaucrats will create massive bubbles in one or another sector of the global economy, which will lead to renewed economic and financial instability some time in the future," he wrote.
"There is a possibility that equity markets will move, in 2010 and thereafter, into a volatile trading range as was the case in the 1970s."
Peter Gibson, head of portfolio strategy at CIBC World Markets, agrees that the Fed's low-rate policies are pivotal to understanding the stock market's volatility - and while those low rates might encourage rising debt levels, he argues that they are also the result of excessive debt.
Mr. Gibson maintains that because of high government and consumer debt, the U.S. has been teetering on the edge of deflation for years - and the Fed is forced to keep interest rates low and in a relatively narrow range to keep it from toppling over the edge. The result has been volatile, up-and-down market swings as bond yields move toward the upper and lower ends of that range and the Fed does a delicate dance to keep deflation at bay.
"If you look at those rallies and declines, each one if them is essentially the Fed creating a bubble and then putting out a fire," he says. "We're playing for time. We're postponing a crisis."
Because falling bond yields in this scenario imply a threat of deflation (a serious negative for the stock market), stock prices and bond yields have taken to moving in the same direction over the past decade - the opposite of what used to happen historically.
And because bond yields remain locked at relatively low levels, even small movements in yields are much bigger in percentage terms than they would be at higher levels - and the corresponding price movements in stocks are also amplified as a result.
"The two are locked in this dance," he says.
Mr. Shiller argues that the debt problems that surround this precarious and volatile rate dance - and, by extension, the Lost Decade for stocks - are part of the risk-taking psychology that he believes are at the root of the problem.
"High debt levels are a symptom of our speculative culture," he says. "It's a fundamental change in our society. People have reframed their sense of personal identity - they think of themselves now as smart investors.
"I suspect this is going to be a long, enduring change - we will have higher volatility," he says. "It seems to me that we are more bubbly."
David Parkinson