The Lesson of the Bird in the Bush
“How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions?” Alan Greenspan, December 5, 1996
Another day, another market record. The Dow has set some 36 record high closings since the 2016 presidential election. Wall Street has shrugged off a weak GDP, soaring sovereign debt, low inflation, White House scandals, terror attacks, the Comey hearings, and one of the most contentious political climates since the 1960s.
With respect to the markets, we’ve read and heard the words “all-time high” so frequently this year that the efficacy of America’s oldest index comes into question. The DJIA charts the daily price movements of our largest and most storied companies, and it now seems to have lost relevance. We are illogically confident, unreasonably upbeat, and many would say foolishly optimistic about equities. It is what Alan Greenspan called “irrational exuberance,” or a state of investor enthusiasm that has no basis in fundamentals.
The truth is, we can’t help ourselves. Persistently low inflation has created the perception of lower risk and reduced uncertainty. Stocks have been on a seemingly infinite trajectory of “up,” and we have all been jumping in on the profit party. We have thrown caution to the wind, gone all-in, and quite simply let it ride. The year 2017 has been an unusually lucky roulette game at an overly crowded table where the Dow has managed to find the pocket week after week as we’ve gone “straight up” and “double zero” in a profit-crazy round of risk.
According to Nobel Prize-winning economist Robert J. Shiller, the author of the book Irrational Exuberance, we “are drawn to it partly through envy of others' successes and partly through a gambler's excitement.” We are, after all, human and subject to the emotional ruse of a speculative bubble, which Shiller says “spreads by psychological contagion from person to person…despite doubts about the real value of an investment.” Three decades later, we have once again tapped into Gordon Gecko’s Wall Street where “greed clarifies, cuts through, and captures the essence of the evolutionary spirit.”
Chronic optimism can often breed complacency, and the majority of fund managers in the U.S. now warn that the market is the most overvalued it has been in 20 years. Stretched valuations and profit weaknesses are deemed to be extraordinarily high. According to a Bank of America survey in late March, more than 80 percent of fund managers voted U.S. equities as the most overvalued region in a market comparative with Europe, Japan, GEM (Global Exchange Market), and the U.K. And what do those same managers think will ultimately tame the charging bull? Throughout history, rising interest rates and weak earnings have taken down even the mightiest of market forces, and these elements are now both in play.
The true peril of irrational exuberance is that it is wholly deceptive. Sound decision-making is muddled by misleading market indicators, competitive groupthink, and veiled bubbles that on any given day can rupture and collapse. So for those looking for retirement security, Wall Street in 2017 is simply not the bird in the hand—but very much an unfamiliar and unpredictable bird lurking in the bush.