Irrational Exuberance
Irrational Exuberance
1. High consumer confidence. (from sources such as the Consumer Confidence Index and the Michigan Consumer Sentiment Index) For example, both indexes peak during the 2000 bubble.
2. High PE ratios.
When the market reaches PE ratio extremes on the high or low end there is a reversion to the mean. The pattern of market bubbles to be linked with high PE ratios is illustrated by the first graph above. Note the very high PE ratios in the 2000 bubble. To cause PE ratios to return to the average, prices must fall faster than earnings or earnings must rise faster than prices.
The trend in S&P 500 price and PE ratios is an inverse relationship. The graph above illustrates that periods of low S&P PE ratio were followed by periods of greater price increase than periods with high S&P PE ratios.
3. Increasingly optimistic analyst forecasts.
4. Increasing or high public market optimism.
5. Increasing market interest and greater volume of financial news
6. Creation of more investment clubs than average. This data is measured by the NAIC. This chart shows the growth in the number of investment clubs. Peaks are present at many market bubbles.
7. Rise in volume of shares traded.
8. New era thinking. In many historic bubbles, technological advances caused people to think that they were an a “new era” that rationalized the dramatic increase in stock market prices.
9. Growth not supported by earnings growth.
This information was extrapolated from Irrational Exuberance. It is important to note that many of these factors seem to be interrelated. The book also has other interesting ideas. One of the explanations for dramatic market increases was the feed back loop. Consistent price increases cause people to buy stock which increases the price causing the pattern to repeat. Bull market indicators were also extrapolated from the book. Some indicators were, important new technology and government changes supporting the market system.
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