Irrational Exuberance in Our Markets

By Mitchell Anthony

November 23, 2021


Alan Greenspan’s infamous speech in 1996 hit the nail on the head when he warned the world about the irrational exuberance that existed in both the US economy and US financial markets.  For the most part corporate leaders and investors failed to take heed of the notice until it was too late. The exuberance centered heavily on greedy blind ambition as well as ignorance that drove capital into Internet and tech oriented businesses that had far too optimistic visions for their products and product cycles.  Some had no products or services at all that were rational.  The exuberance caused these businesses to invest heavily in human capital that they had to divest quickly thereof when the bottom fell out at the end of that dot-com cycle in 2000. The fallout from the tech sector dominoed into other sectors and caused a classic economic bust that led to one of the worst equity market declines on record.  Similarly the economic strength from 2002-2007 that preceded the great recession of 2009, saw greedy blind ambition drive over-consumption in the housing market into a state of irrational exuberance that resulted in a massive economic bust that took a decade to put behind us.

Equity Markets and Real Estate Assets have surged dramatically over the past two years, with everything from cryptocurrency to meme stocks exploding in value, causing investors to wonder about the existence of rot in our economy? Could we be on the verge of another bust for the economy and the markets?

The Exuberance in Equity Markets and the Global Economy. 

Thus far irrational exuberance has been notable in Global financial markets, but it has been hard to find evidence of this concern in any significant industry within the US economy or the globe. There are a few seemingly insignificant economic areas with overly optimistic business plans and excess capacity worth noting. Greed will always be a problem if the regulatory environment is not taught.  After the 2009 debacle reforms have been put in place for greater transparency and tighter regulation of activities prone to fraud.  As a result the current environment seems benign.  Transparency has stopped fraudulent leadership and kept exuberance in check.

Blind Ambition and arrogance is visible in some industries but seemingly under control again thru this tighter regulation and required transparency.  Elon Musk seems to have problems with realistic time frames for product development and implementation.  Self-driving cars are still in the distant future, however he still brims with optimism but yet constantly reminds investors that his stock is overpriced.

The Crypto Currency Industry has expanded maybe in an overly exuberant irrational manner?  There are lots of bitcoin dealers, transaction brokers, custodians, and related technology companies involved in the mining, and block-chain ecosystem development that are employing thousands of people on speculation that this industry will find a path to profitability.  (ie Marathon).  Clearly Crypto is lacking the needed transparency and regulation to have a respected path forward.  Fraudulent activity has already occurred and found its way into this new industry.  Fortunately this industry is still far too small to be a problem for the economy if it busts.  For example, one of the larger and publicly traded crypto companies, Coinbase, employs just over 1,000 people, while a companies like AMZN and Walmart employ more than 1 million each.

Business plans for currency companies hope to serve lots of industries but services are thin and current businesses are mostly working to offer:

  • Tokenization of asset ownership.
  • Transaction payment.
  • Infrastructure of the currencies.

Another Industry that is problematic is SAAS (Software as a Service) and has lots of players and maybe too much capacity making it ripe for consolidation and layoffs. Subindustries include Productivity Services, Inventory Management, Fintech, and Cyber Security.

Irrational Exuberance in the Global Markets.

The US Equity Market currently has historically high PE’s and PEG ratios despite high transitory inflation in our economy.  Exuberance is very visible in in the stock prices of secular growth names like TSLA and NVDA.  Several cyclical and industrial names likewise have PEG ratios that seem exuberant.  Live Nation has a PE of 112, GameStop  has as a PE of 1400, and AMC Entertainment has a PE over 1000.  These extreme valuations are likely a product of mania like purchases from reddit traders rather than stable investment behavior.

Main street names are highly valued with the S&P500 holding a forward PE over 21.  Still below the irrational exuberant valuation of stocks during the dot-com era of 1999 when the S&P500 forward PE was over 26.  Some exciting mega-cap secular growth company valuations have become unexplainably high and seem rooted in mania like liquidity flow. TSLA has a forward PE of 130 and a PEG ration of 3! NVDA has PE of 62 and PEG of 3.  Zoom Media and Shopify further illustrate this point.  Today’s high equity valuations seem justified however by the ultra-low levels of rates and lenient central bank policy toward inflation, and really great products from these innovative corporate American superstars.

The Exuberance is also visible in SPACs.  The SPAC (special purpose acquisition company) has been innovated and allows more companies to go public and access investor capital for use in financing speculative investment ideas.

European Markets are full of highly valued Cyclical Names that reflect exuberance.  Monetary Policy and rates are similar to the US but the outlook for growth is more subdued. Chinese Markets are Cheaper than US markets with PE ratios of 16-17 and PEG ratios of 1.5, but still very expensive from historical valuation comparisons.  In China Monetary Policy is unclear and their liquidity pump may be slowing? Growth clearly is slowing as Gov’t stimulus has changed course it would appear.  Chinese Markets have corrected and exuberance there seems to be in decline.

Current Economic Exuberance is Unlikely to cause a BUST or even a Recession.

The exuberance present today is almost entirely rooted in asset prices rather than economic capacity.  The asset price exuberance is not large enough and pales in comparison to past cycles when the demise of highly valued assets occurred and brought the economy down with it due to the destruction of wealth.  The Market Cap of all Crypto Companies (1-2 trillion) today is a fraction of the 40 trillion or more of real estate that halved in the 2009 downturn.  The Total Market cap of all gold today is over 11 Trillion and the total US equity market is nearly 50 trillion in value. These assets are stable and are not founded poorly or in question such as Bitcoin.

Overall the US and global economies are seeing below trend growth without any notable segments that are experiencing boomy exuberant growth that would lead to an economic bust.  Where consumption is strong it appears to be a result of pent up demand and is likely a Covid rebound.  Affordability has become an obstacle as cheap money has been replaced with higher priced homes and cars.  We have however seen some acceleration in past consumption trends in Housing, Autos, and Entertainment.

Central banks have become quite good at keeping the major economic engines of the global economy from overheating and further Washington policy makers and their global equivalents have been there to provide more than enough stimulus when conditions have slowed to much.  All this makes for a strong case for a new economic environment of long term stability.

The Classic Boom and Bust Economic cycles of the past century may be gone for decades!

The US economy is likely to ebb and flow from modest growth to moderate growth for years.  Exciting uncontrollable consumption is just not visible.  Consumers are not exuberant about any products or services currently available in US economy.  Some exceptions might exist like artificial intelligent devices.  The Current economic cycle is likely going to be a repeat of what we saw from 2010-2020 where things ebbed and flowed.  The Central bank will continue the proven process of braking and stimulating that will enable long stable cycles of growth.  We see a long period of economic stability on horizon. The classic 7 year boom and bust economic cycle may well be gone forever.