Retail Investors Show "Exuberance"

The word "exuberance" has a special meaning for investors. Back in 1996, then-Federal Reserve chair Alan Greenspan gave a speech as stock prices rose during the "dot-com" boom. He asked: "But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions ...?" When the Fed chair starts "just asking" questions about exuberance, people take note. 

But any one who took Greenspan's speech as a prediction of a near-term drop in the stock market missed out because the "exuberance" had a few more years to run. The S&P 500 index was at about 750 at the time of Greenspan's speech in December 1996. It had doubled in value during the previous five years. After Greenspan's speech, it would double again, topping out at nearly 1500 in September 2000, before sagging back to about 820 in September 2002. 

Still, when those in the financial community use the language of "exuberance," my eyebrows go up. The March 2021 issue of the BIS Quarterly Review from the Bank of International Settlements uses "exuberance" a couple of times in a lead article, "Markets wrestle with reflation prospects" (pp. 1-16). Here's a snippet (references to graphs and boxes omitted): 

Equities and credit gained on the back of a brighter outlook and expectations of greater fiscal support, with signs of exuberance reflected in the behaviour of retail investors. ...

Low long-term interest rates have been critical in supporting valuations. Since recent US price/earnings ratios were among the highest on record, they suggest stretched valuations if considered in isolation. However, assessments that also take into account the prevailing low level of interest rates indicate that valuations were in line with their historical average. ...[E]quity prices are particularly sensitive to monetary policy in environments akin to the current one, featuring high price/earnings ratios and low interest rates.

Even if equity valuations did not appear excessive in the light of low rates, some signs of exuberance had a familiar ring. Just as during the dotcom boom in the late 1990s, IPOs [initial public offerings] saw a major expansion and stock prices often soared on the first day of trading. The share of unprofitable firms among those tapping equity markets also kept growing. In addition, strong investor appetite supported the rise of special purpose acquisition companies (SPACs) – otherwise known as “blank cheque” companies. These are conduits that raise funds without an immediate investment plan.

The increasing footprint of retail investors and the appeal of alternative asset classes also pointed to brisk risk-taking. An index gauging interest in the stock market on the basis of internet searches surged, eclipsing its previous highest level in 2009. This rise went hand in hand with the growing market influence of retail investors. In a sign of strong risk appetite, funds investing in the main cryptoassets grew rapidly in size following sustained inflows, and the prices of these assets reached all-time peaks ...

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