Irrational Exuberance? I Have No Idea

12 Jul

Irrational Exuberance? I Have No Idea

Let me get this out of the way now, by thanking Alan Greenspan (and professor Robert Shiller), for allowing me to utilize the headline phrase ‘Irrational Exuberance’. As you’ll see in that link, irrational exuberance is “unsustainable investor enthusiasm that drives asset prices up to levels that aren’t supported by fundamentals.” In layman’s terms, there’s no real basis for sentiment. Due to the nature of my profession I have the benefit of watching the financial markets closely and I must admit, I’m reminded quite often that despite being glued to this on a daily basis, I have no idea what’s going on. If you’re reading this, that statement might be a cause for concern, but let’s be frank with each other. Who really does? The problem is that someone will always be right, and someone will always be wrong. Rather than try to hit a moving target, read the rest of this article, and then decide if anyone truly knows what might happen going forward.

Take a look at this chart, courtesy of Big Charts:

That chart illustrates the last 10 years of returns from the S&P 500 Index. That index has experienced gains in eight straight years, and it’s been nearly six years since a 20% decline has happened. Speaking of professor Robert Shiller, the Shiller PE Ratio for the S&P 500 currently sits at 29.91. A  P/E ratio is simply price-to-earnings, which can be calculated as Market Value per Share/Earnings per Share. Shiller’s ratio is calculated a bit differently, in that it is cyclically adjusted, which removes any bias prone to wild swings. Looking at that link, you’ll notice that the mean for this ratio over the last 136 years is 16.76. Using those simple data points, one could argue that the overall market is rather expensive.

Coming into 2017 after an election with such magnitude, I don’t think many would have predicted below-average volatility in the financial markets, but alas here we are with incredibly low levels in the VIX Index (the unofficial market fear gauge). Despite all of the noise surrounding the financial markets, whether it be political or across the entire globe, the resiliency shown by markets has been nothing short of amazing. Once coined the most hated rally, it’s hard not to wonder just how complacent investors have become during what is now the third longest economic expansion on record.

The problem with identifying bubbles is that it’s the bubble itself that makes it very difficult to discern between a healthy rise in prices and full blown euphoria. While formulas and ratios much like the Shiller PE ratio above are nice, they aren’t bullet proof in predicting the future, as nothing can understand or account for the human element. Economic indicators are extremely important and, but you have to look at sociological areas as well. There are no metrics for capturing whether or not everyone is talking about stocks or real estate, and their ability to “get rich” from those assets. You can’t quantify in an efficient way how many people are quitting their jobs to get involved in day trading or becoming a real estate broker. I have yet to find an index that can capture how often someone is getting ridiculed in an ardent manner for not being “all in” on stocks or some other foolproof asset. What I do know is that the sociological and economic elements need to be accounted for together, with neither being the sole manner to evaluate the current environment. Is the recent financial crisis of 2008 and 2009 still fresh enough in people’s minds to keep a bubble from inflating too much? It’s possible, and while I think the terms ‘bubble’ or ‘crash’ can be used far too much, I can’t help but wonder if complacency is the film the bubble is wrapped in this time.

In some ways, it feels like the financial crisis that unfolded nine years ago has completely changed the way investors approach the financial markets, but in other ways it feels like too many have already forgotten the lessons that should have been learned as a result of that crisis. Am I predicting a continuation in the current rally, or conversely, a market crash? Absolutely not, and that’s why I mentioned at the beginning of this article that no one should be making such bold claims, regardless if they are a financial professional or not. The truth is that we don’t know what will happen going forward, especially on a day-to-day basis, but we can be equipped with knowledge and an understanding of how to approach investing, regardless of the environment. We learn from what has happened, not what might happen in the future. So the burning question after all of this;  how do we identify whether or not exuberance is irrational or not? That’s precisely my point, because until it actually happens, I have no idea.

 

Adam M. Sutton is the founder and president of Cornerstone Financial Partners. Adam is a financial planning professional, specializing in retirement income planning and wealth optimization strategies. He is a Series 66 licensed Investment Advisor Representative (IAR), as well as life, accident & health insurance licensed and is certified to address long-term care. Cornerstone Financial Partners is a privately held, independent financial planning firm.

Full Disclosure: This information does not constitute investment advice. This article is published and provided for informational purposes only. None of the information contained in the article constitutes a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. To the extent any of the information contained in this article may be deemed to be investment advice, such information is impersonal and not tailored to the investment needs of any specific person. Cornerstone Financial Partners does not provide legal or tax advice, and the contents of this message are not intended to constitute such advice. Please seek an appropriately licensed individual for legal or tax advice in relation to your individual situation.