Irrational Exuberance is Back

 Financial FAQs

“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.” Robert Shiller, Irrational Exuberance

FREDS&P

Both the DOW and S&P 500 indexes of the largest publicly traded companies in the U.S. are at record levels, despite Donald Trump having just raised tariffs on 90 countries that he doesn’t like for some reason. April 2 was the last time he made such an announcement and the S&P plunged 828 pts. on the same day (see dip in graph), and the DOW more than 1,000 pts. before resuming their climb.

Yet the financial markets aren’t panicking this time, maybe for the wrong reasons. Their over enthusiasm, which was first termed irrational exuberance by Fed Chair Alan Greenspan in the mid-1990s as a warning that stocks were overpriced, has created a new asset bubble much like the dot-com asset bubble, and housing bubble that led to the Great Recession.

And such massive overinvestment in new technologies such as the current AI investment boom haven’t turned out well, historically.

Nobel Laureate Robert Shiller first wrote about it in his 2000 book, Irrational Exuberance, just before the bursting of the dot-com speculative bubble, which was precipitated by overinvestment in communication technologies such as the nationwide laying of fiber optic cables.

He said at the time: “I define a speculative bubble as a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increases, and bringing in a larger and larger class of investors who, despite doubts about the real value of an investment, are drawn to it partly by envy of others' successes and partly through a gamblers' excitement.^”

Companies are investing $trillions in developing AI, which is powering the largest Magnificent 7 tech stocks such as Apple and Facebook to record highs. Market analysts on CNBC have noted that ten stocks are driving 40 percent of the market’s current rally.

Yet just 9.4% of U.S. businesses used AI in July, including machine learning, natural language processing, virtual agents, and voice recognition, according to the Census Bureau as cited by Barron’s Megan Leonhardt.

S&P members’ current earnings per share reflect this. Stock prices have climbed to 29 times earnings which, according to Professor Shiller’s research, is approaching irrational exuberance territory. This is double the S&P’s historical EPS average price of 15 times earnings over the past 100 years that Dr. Shiller has researched.

The markets seem to be ignoring Trump’s erratic behavior for other reasons as well. This is in part because of investors’ belief that inflation is mild, though still rising. The Fed’s favored PCE inflation index for June increased 2.6 percent. Excluding food and energy, the PCE price index increased 2.8 percent from one year ago, still above the Federal Reserve target inflation rate.

And the long-awaited interest rate cuts financial markets haven been hoping for could begin in September after the very weak July unemployment report that caused Trump to fire the BLS Director.

The markets are also ignoring the damage Trump’s higher tariffs will cause to economic growth. History has shown that stagflation is a recurring problem, even during the COVID-19 pandemic. Supply chains dried up then as the world economies shut down, elevating inflation. And supply deliveries have already slowed from the effects of Trump’s on-again, off-again executive orders, as countries look for ways to reroute their exports.

Maybe the greatest sign of irrational exuberance is investors’ assumption that TACO Trump will eventually settle tariffs back to the 10 to 15 percent rates that he initially promised. But when?

Trump and Republicans have always had a problem with the truth and economic facts (like who benefits most from tax cuts), as has been pointed out by those professionals whose job it is to ascertain the facts (with many losing their jobs because of it).

Irrational exuberance has seriously damaged financial markets in the past and caused $trillions in losses. It happens when investors ignore financial facts that aren’t convenient or follow the herd rather than make the effort to read below the headlines.

What will happen this time when market investors realize this administration doesn’t believe in the facts at all?

Harlan Green © 2025

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Nobelist Daniel Kahneman on Thinking, Fast and Slow

Financial FAQs

Amazon

Thinking, Fast and Slow; what else should Nobel Laureate Daniel Kahneman be noted for, the son of Lithuanian Jewish parents fleeing the Russian Empire in the 1920s who grew up to the sound of black boots marching during the Nazi occupation of Paris, if not the study human behavior in both wartime and peacetime?

This was the second year Dr. Kahneman came to Westmont’s annual Breakfast Lecture series that packed the Santa Barbara Hilton’s largest ballroom. I’m sure many were there because they were looking for some insight into how our species may react to the current coronavirus scare that some are characterizing as a ‘Black Swan’ event (mostly economists), meaning a very serious event with no predictable outcome.

Dr. Kahneman emphasized that our decision-making propensities come from different parts of the brain that cause us to both ‘narrow frame’ (fast process) and ‘broad frame’ (slow process) the information we take in. And we need both parts to reach a rational decision that is in our best interests.

We have a tendency, or bias, to come to a conclusion or make a decision quickly, but Dr. Kahneman says not so fast! We need the slower-thinking side of us to see the larger picture. He said it can be just a matter of closing one’s eyes for a few minutes that slows down our thought process while allowing us to process what we’ve just taken in intuitively.

We should take the time to collect all the pertinent, ‘cognitive’ facts, in order to slow down our first reaction to what is right in front of us. He used several examples of narrow vs. broad frame thinking, such as forecasting future events, or diagnosing the high rate of skin cancer among farmers.

I was particularly interested in his take on how we make economic decisions. He is at the foundation of behavioral economics, or how humans make financial decisions that are not always in our best interest; particularly if we allow so-called free, unregulated financial markets to make choices for us.

There are now at least three Noble prizes that have been awarded for information biases in how we take in information and make decisions on how to intelligently invest. And they are mostly Keynesian, or neo-Keynesian economists that believe governments must take an active role in regulating markets to prevent excessive speculation, for instance, as happened with the Dot-com bubble in 2001, or housing bubble that resulted in the Great Recession.

Nobel economist Robert J Shiller described in his best-selling book, Irrational Exuberance how many investors and homebuyers relied on rumor, hearsay, or word of mouth, rather than serious research to buy a home, or invest in the financial markets and thereby drive up asset prices (such as housing) to unsustainable levels.

Economists and Psychologists call it herd behavior when investors flock to a particular investment because others are doing the same, rather than researching the history of the company or index to see if it is overvalued.

Dr. Kahneman and his partner, Amos Twersky, found that humans have an optimistic bias in forecasting favorable outcomes that we must be aware of, when making decisions based on those forecasts. We therefore need to look at the broader picture.

How will the lowering of interest rates, as the Fed is currently doing, affect both poor and wealthy consumers, for instance? Should we save more and spend less in the event of an economic slowdown or recession?

Stocks are overvalued in this 11^th year of the current recovery just by looking at the current price-to-earnings ratio of the S&P. Why? The record profits of those corporations cannot be sustained with slower population growth and labor productivity—the two main factors that determine economic growth. Their earnings, the denominator of the P/E ratio, will therefore shrink, causing the ratio to rise above historical levels, hence certain stock assets become overvalued and will eventually fall.

That is what happened during the 2001 Dot-com stock bubble and 2007-09 Great Recession. P/E ratios soared to levels last seen before the Great Depression, which means history does provide lessons, if heeded.

Here are two of behavioral economist and Nobel prize-winner Robert J Shiller’s most memorable statements in Irrational Exuberance: “ 'It amazes me how people are often more willing to act based on little or no data than to use data that is a challenge to assemble.”…'The ability to focus attention on important things is a defining characteristic of intelligence."

We know it’s best to slow down one’s thinking process before making an important decision. But how often do we?

Harlan Green © 2020

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen