By Mark Hulbert
There's a lot of talk these days about the return of "irrational
exuberance" -- the frothy stock market seen in the internet-stock
bubble of the late 1990s. But a close look at the data suggests
things are nowhere near that heated.
That doesn't mean the stock market won't fall in coming months,
of course. But if it does, it will be for reasons other than
speculative excesses rivaling those of two decades ago.
The term "irrational exuberance" traces to a now-famous speech
in December 1996 by Alan Greenspan, then chairman of the Federal
Reserve. Persuaded by comments by Yale University professor Robert
Shiller, Mr. Greenspan wondered, "How do we know when irrational
exuberance has unduly escalated asset values?" The comment caused a
sensation among investors, and for years, the term and the date Mr.
Greenspan uttered it was referenced whenever the press published
stock charts on milestones in the markets.
Though the warnings from Mr. Greenspan and Prof. Shiller were
sounded early, they were remarkably prescient. In the 2 1/2 years
following the bursting of the internet-stock bubble, from March
2000 to October 2002, the Nasdaq Composite Index fell 78%. Years
later, Prof. Shiller would be awarded the Nobel Prize in economics
in part for the research that became the basis of his book
There of course is plenty of anecdotal evidence that individual
investors today are rushing into the market in a way reminiscent of
the late 1990s. Commission-free brokerage platforms have
experienced a surge in new customers, for example. And we're seeing
huge swings in individual stocks -- sometimes, for little to no
reason at all. Consider:
-- In the two weeks after Hertz declared bankruptcy, the
company's stock doubled, and investors appeared eager to
participate in a secondary offering. The company subsequently
withdrew its offering after security regulators vowed to review
-- Though fracking company Chesapeake Energy indicated in May
that it likely would have to declare bankruptcy, in just one
session in early June its stock jumped more than 180%. The company
in late June did formally file for chapter 11 protection.
-- On another day in June, stock in Chinese real-estate company
Fangdd Network Group Ltd. jumped nearly 400% -- on no news. Many
suspect that day traders erroneously believed investments in the
company were bets on the performance of the highflying FAANG stocks
-- Facebook, Amazon.com, Apple, Netflix and Google (owned by
Alphabet) -- and that once the Chinese company's stock started
rising, algorithmic trading took over.
Given these examples, it is hard to argue that there aren't
pockets of irrational exuberance in the market. But that is far
different than concluding that the market as a whole is as frothy
as it was in the late 1990s. Our memories are notoriously
unreliable when trying to make such comparisons, which is why it is
important to rely on objective data.
Perhaps the most systematic effort to quantify investor
exuberance was conducted 20 years ago by Malcolm Baker, a finance
professor at Harvard Business School, and Jeffrey Wurgler, a
finance professor at New York University.
In research done in the wake of the bursting of the
internet-stock bubble, they identified five variables for comparing
investor sentiment at different points in time and showing how that
relates to stock performance. A composite of those indicators shows
that the current market is far less exuberant than in the late
It isn't even close, in fact. Consider what each of these five
indicators currently is saying about the prevailing market
-- Two measures relate to the new-issue market -- the number of
initial public offerings and their average first-day return. In
calendar 1999, according to data from University of Florida finance
professor Jay Ritter, there were 476 IPOs, versus a much leaner 44
so far this year. The 1999 IPOs' average first-day return was 71%,
more than double this year's 34%, indicating a much cooler market
today. Although, as you can see from the accompanying chart, this
year's average return is the highest since 2000.
-- The third variable tracks how public companies raised their
capital: equity vs. debt. The theory goes that during periods of
irrational exuberance, companies increasingly turn to the equity
market to raise capital. In calendar 1999, the last full year
before the top of the internet bubble, the equity proportion stood
at 18%. So far in 2020, in contrast, it is less than half that, at
-- Another variable is the relative valuations of
dividend-paying and non-dividend-paying companies. Profs. Baker and
Wurgler think this is a good proxy for investor exuberance, because
dividend payers tend to be older, more-established companies;
during periods of speculative excess, however, investors usually
turn toward highflying growth stocks that don't pay dividends.
The professors report that, at the top of the internet-stock
bubble, the price-to-book ratio of the average nonpayer was more
than double that of the average dividend-paying company. Today,
according to FactSet data, it is nearly the reverse: Dividend
payers sport an average price-to-book ratio that is 44% higher than
for the typical nonpayer.
-- The final indicator is the average closed-end-fund discount,
which is the amount by which the average fund's price is below its
per-share net asset value. At the market's bottom in March, this
discount widened to one of the largest in history, suggesting
extreme investor pessimism, according to Ryan Paylor, a portfolio
manager with Thomas J. Herzfeld Advisors Inc. Though this average
discount has narrowed since March, Mr. Paylor says that the
discount remains deep by historical standards, indicating that
closed-end fund investors "are leaning more towards fear than
Given these stark differences between the market environments of
the late 1990s and today, one may wonder why so many observers are
quick to point to irrational exuberance. Is it more than just
faulty memories at work?
One factor could be a predisposition among many bearish
commentators to judge those who throw caution to the winds as
having defects of character. Will Goetzmann, a finance professor at
Yale University, says that this tendency appears especially strong
right now among those who wish to rationalize why they missed the
stock market's 40%-plus rally from its March low. "People seem to
be quick to judge those who participated in the rally as being
stupid," Prof. Goetzmann says.
It's not just that they believe the market will soon fall; they
are prejudging those who will lose when the bubble bursts as
getting what they deserve.
We'll leave the inscrutable question of what investors deserve
to others -- forecasting the stock market's direction is difficult
enough. At a minimum, we can confidently say that the current
market environment isn't nearly as exuberant as it was at the top
of the internet-stock bubble.
Mr. Hulbert is a columnist whose Hulbert Ratings tracks
investment newsletters that pay a flat fee to be audited. He can be
reached at firstname.lastname@example.org.
(END) Dow Jones Newswires
July 05, 2020 21:00 ET (01:00 GMT)
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