Irrational Exuberance

Professor (and Nobel Memorial Prize in Economics winner, 2013) Robert Shiller's book Irrational Exuberance (originally 2000, with newer versions in 2005 and 2015) does a methodical job of exploring psychological factors behind market "bubbles", mainly focusing on corporate stocks and housing prices. From the preface to the second edition:

... this book [is] about trying to understand the change in thinking of the people whose actions ultimately drive the markets. It is about the psychology of speculation, about the feedback mechanism that intensifies this psychology, about herd behavior that can spread through millions or even billions of people, and about the implications of such behavior for the economy and for our lives. Although the book originally focused directly on current economic events, it was, and is, about how errors of human judgment can infect even the smartest people, thanks to overconfidence, lack of attention to details, and excessive trust in the judgments of others, stemming from a failure to understand that others are not making independent judgments but are themselves following still others—the blind leading the blind.

Shiller wisely points out the dangers of paying excessive attention to market fluctuations, of distrusting social institutions, of imagining that one can become wealthy without work, and of failing to "make conservative preparations for possible bad outcomes." He also warns in the preface to the first edition:

If we exaggerate the present and future value of the stock market, then as a society we may invest too much in business start-ups and expansions, and too little in infrastructure, education, and other forms of human capital. If we think the market is worth more than it really is, we may become complacent in funding our pension plans, in maintaining our savings rate, in legislating an improved Social Security system, and in providing other forms of social insurance. We might also lose the opportunity to use our expanding finanial technology to devise new solutions to the genuine risks—to our homes, cities, and livelihoods—that we face.

Shiller's bottom line, also in the original preface:

Most investors also seem to view the stock market as a force of nature unto itself. They do not fully realize that they themselves, as a group, determine the level of the market. And they underestimate how similar to their own thinking is that of other investors. Many individual investors think that institutional investors dominate the market and that these "smart money" investors have sophisticated models to understand prices—superior knowledge. Little do they know that most institutional investors are, by and large, equally clueless about the level of the market. In short, the price level is driven to a certain extent by a self-fulfilling prophecy based on similar hunches held by a vast cross-section of large and small investors and reinforced by news media that are often content to ratify this investor-induced conventional wisdom.

... all excellent cautions, especially in the current environment of extremely high stock market prices compared to corporate earnings!

(cf The Cancer Ideology (1999-05-19), Money Wisdom (2001-05-20), Hopeful Rejoinders (2001-06-03), Pop Goes (2001-06-19), Bubble Busters (2002-02-06), Dow Theory (2002-07-27), Next Economy (2005-01-31), Later and Milder (2005-03-01), Back to Normal (2008-11-13), Odlyzko on Bubbles (2012-01-25), Boom Times Loom Soon (2012-08-30), Harry Browne Rules of Financial Safety (2019-12-24), Shiller Price Earnings Ratio (2021-03-29), Great Crash (2021-06-01), ...) - ^z - 2021-08-13