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Rational exuberance? Animal spirits, Robert Shiller, and Donald Trump

We are often asked by investors whether looking for ‘episodes’ as investment opportunities can be dangerous. After all, if investors are panicking, can’t this become self-fulfilling?

Indeed it can and in a speech two weeks ago, Robert Shiller outlined some of the reasons why. Shiller was speaking at the American Economic Association on “Narrative Economics”. He discussed how the stories we tell ourselves, and how they spread, have important implications for what goes on in the real economy. In particular he focused on the role of stories in creating the conditions for a recession.

Looking at the case studies of the recession of 1920, the Great Depression in the 1930s, and the financial crisis of 2008, Shiller examined how it is that individuals and companies come to make the decision to spend less, which is after all the key characteristic of a recession.

He pointed at the importance of stories in fostering pessimism and shaping expectations in ways that economic models simply cannot capture.

It is not just in the case of recessions that stories will be significant; Shiller himself wrote extensively about the housing and stock bubbles of the late 1990s. Or, consider hyperinflation and bank runs, both powerful economic forces that are driven by how ordinary men and women perceive the future. If we are shown queues of people looking to withdraw their deposits or shoppers clearing the shelves it can have far more impact than any set of data.

Are stories more important than ever?

Today, as Donald Trump is inaugurated as President of the United States, there is much attention being paid to the importance of narrative. Shiller describes Donald Trump as “a master of narratives” and like Brexit voters before them, those who voted for Trump have frequently been described as a having been won over by “populist” stories. There is a sense that owning the narrative has become more important than before, and we have previously discussed how polarisation could be the result.

Trump’s ability or otherwise to control the narrative will be deeply interesting for economists. Central Bank actions are arguably all about trying to boost animal spirits: lower rates are supposed to make us lend for productive activity, supporting banks is about restoring ‘faith,’ and ‘forward guidance’ is about managing expectations.

Strangely, and perhaps coincidently there are some signs that animal spirits are picking up just as Trump comes to power. Business confidence was already picking up from extreme lows in many parts of the world:

Comparable consumer data is lagging and shows less improvement thus far, while recent all-time highs in US stocks have grabbed headlines.

More recently, the question we are asked by investors is: “are investors too optimistic about Trump?” As we have noted, not all of recent price action can be explained as Trump-driven. Moreover the impacts of optimism on the real economy are highly complex. Many have argued that Trump could not deliver many of his promises due to constraints on the budget. This is true but only from an ‘other things being equal’ perspective. Were Trump to really prompt an improvement in animal spirits then growth would give him far more room to act.

The interrelationships between fundamentals and attitudes are highly complex, which only further explains why forecasting economic fundamentals is almost impossible (an idea that is closely related to George Soros’ theory of reflexivity). Investors need to accept the complexity that narratives can create, while avoiding falling victim to the convenient stories that often drive bad investment decisions.


The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.