Tuesday, March 30, 2021

Irrational Exuberance

 

Irrational Exuberance

There’s no question markets have been volatile this year. If we peel back the top layer, there are many different events we can blame it on: inflation, treasury yields, the Fed and interest rates, Covid vaccines, unemployment, even the colder than normal February. But, what if we didn’t peel back the top layer? Instead, we focus on a potential over-arching theme as a way to over-simplify what’s been happening in the stock market.

In a December 1996 nationally televised speech, then Chair of the Federal Reserve Board Alan Greenspan referred to the behavior of stock market investors as “irrational exuberance”. Since then, this term – irrational exuberance – has been used to in conjunction with speculative and instable markets.

In his bestselling book aptly titled Irrational Exuberance, author/economist/Nobel prize winner Robert Shiller defined it as,

“the psychological basis of a speculative bubble. I define a speculative bubble as a situation in which news of price increase spurs investor enthusiasm, which spreads by psychological contagion from person to person, and, in the process, amplifies stories that might justify the price increase and brings in a larger and larger class of investors, who, despite doubts about the real value of the investments, are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement.”

One of the longer sentences you’ll see, but by breaking it down and providing some examples we can better understand what it means. And, how it might explain markets today.