Irrational Exuberance Redux – Do Market Fundamental Even Matter Anymore?

Irrational Exuberance Redux – Do Market Fundamental Even Matter Anymore?

During the 1990s, in the midst of the dot-com bubble, the then-Federal Reserve Board chairman Alan Greenspan issued a warning that the American market might be overvalued. He placed the blame on sustained low inflation and lower risk premiums, which can lead to escalated asset values. This is especially true when there is an uneven ratio between market prices, earnings and rates of inflation that collectively create an economy of excess.

Greenspan labeled this economic phenomenon as “irrational exuberance” and cautioned that it could create great uncertainty in the future. The prophetic words, which few financial insiders heeded, came to life three years later when stock markets worldwide hit major slumps.

Indications of an Irrational Exuberance Redux

As the U.S. economy attempts to recover from another devastating recession, just a decade later financial analysts are once again questioning whether we are weaving a false market of irrational exuberance. At first look, the U.S. appears to be riding out a rocky global economy. The Financial Times recently reported that consumer consumption is strong and the job market is regaining momentum. Home sales are up, and the Fed is expected to let interest rates remain at record lows for now.

However, there has been a recent increased flooding of the market with currency as the central banks continue to buy government bonds. According to U.S. News and World Report, “Demand for government bonds has skyrocketed in recent weeks, which has pushed yields down to record lows.” With the 10-year and 30-year Treasury notes hitting their lowest depths in history, the stock markets are surging and mortgage interest rates have fallen.

The Danger in Overlooking Market Fundamentals

Irrational exuberance can easily create a social frenzy that leads to a financial asset bubble. One example is the recent scramble to purchase real estate, which has become a high priority for Americans who have been previously locked into homes that they no longer want. Interest rates are low and total home sales are up 5 percent, marking the best spring in a decade, but so is the median sales price. Respected industry professionals, including Realtor.com, expect the housing market to continue growing but warn that the robust pace cannot be sustained for long. Limited inventory and a competitive buying market are driving up prices as consumers fear not getting their hands on the home of their dreams.

The current scenario echoes many of the issues of the previous housing boom. Ultimately, Americans created a market where the home they purchased was not worth the mortgage they were paying to the bank. This led to a devastating crash that witnessed some of the highest rates of bankruptcies, foreclosures and short sales in history. The fear is that we are heading toward a similar housing bubble.

Cautiously Navigating a Potential Market Bubble

In a piece for Seeking Alpha, John Nyaradi questioned how markets are managing to rally to new record highs when employment and earning reports are so dismal, particularly in the tech and financial services sectors.

The traditional fundamentals of the market seem to be “totally irrelevant as the stock market shrugs off all conventional tools” to gauge the economy, Nyaradi asserts. Financial giants, such as former Fed chairman Ben Bernanke, believe there is actually stronger economic data that we are not currently seeing. Moving forward with this unsubstantiated optimism, new records were set at the end of July in the Dow Jones Industrial Average and S&P 500.

Yet Microsoft, Google, Yahoo and American Micro Devices reported significant dips in quarterly earnings, sinking the value of the once-bankable shares. Other recent economic data indicates that the strength of the dollar is wavering against global peers, falling .5 percent at the end of July. The market fundamentals that we can analyze at the moment do not predict the growth the American market is currently experiencing.

As previous bubbles have repeatedly proven, this investor enthusiasm for stocks with high price/earnings ratios is unsustainable. This is an elementary “lesson that many of us learned the hard way a long time ago,” Nyaradi writes. Cautious investors will steer clear of overvalued stocks, bonds and other financial assets until “fundamentals trump sentiment as they always seem to do,” he advises. While fundamentals do still matter, financial analysts must be careful in using them to predict the future since there are so many outside factors that ultimately drive the market.

Learn more about the latest developments in economic trends on the Personal Money Store MoneyBlog.

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