Irrational Exuberance Revisited

December 4, 2008

Tomorrow marks the twelfth anniversary of the speech by former Fed Chairman Greenspan in which he questioned the strong and lengthy rise of U.S. equity prices and coined the expression “irrational exuberance” to describe the psychologically charged market behavior. The Dow Jones Industrial Average was at 6,437 when he spoke, constituting a 15.4% per annum advance from its low of 1,738 on October 19, 1987, the day of that year’s infamous 22.6% single-day crash. The bull run in stocks continued for another three years, and the Dow earlier this decade made another impressive advance, eventually culminating at a record closing high of 14,165 in October 2007, which was more than twice as elevated as the level at which Greenspan had spoken.

For a while, it had seemed that the questioning of stock market exuberant behavior was one of the few things that Greenspan got wrong, and he too discarded that view and became a big defender of central banks not pricking perceived asset bubbles. It now appears that there were few times that Greenspan was really on to something so correctly as the night he gave that speech. From then until now, the Dow on balance has risen just 2.2% per annum over a dozen years, and the 15.4% pace of climb from October 1987 through December 1996 has been exactly halved to a 7.7% per annum rate of climb from October 1987 to the present time.


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