How Long Will The Party Last?

20.03.2017 • The Economy

By Selva Freigedo – Port Phillip Insider Extra (Australia) –

It was late 1996. Federal Reserve Chairman Alan Greenspan was writing a speech while in his bath tub — where he spent much of his time due to back pain — when he came up with the term ‘irrational exuberance’.

As he recently admitted to The Wall Street Journal, at the time, Greenspan thought the markets were too hot. So he decided to cool them.

There was no Twitter at the time. So he used the term during a televised speech in December 1996. This is what he said (emphasis mine):

‘Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?’

The plan worked. The Tokyo Stock Exchange, which was open at the time of the speech, fell 3%. Other world markets followed.

But the effect was short-lived. Stocks quickly rebounded. It wasn’t until 2000, with the dotcom bubble, that the market collapsed.

That, as you know, was followed by the more spectacular property bubble, which burst in 2008.

Since the bust of 2008, US markets have once again soared to new heights, aided by long-term low interest rates. At time of writing, the S&P 500 has broken a 22-year record — 107 days without closing down by 1% or more. The last time this happened was in 1995.

Much like Greenspan, Goldman Sachs is now trying to coin a new term to explain why investors and traders are acting irrationally: ‘Cognitive dissonance’. Are they also trying to spook the markets? Could be.

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