Irrational Exuberance

by Paul Ruedi

 Former Federal Reserve chairman Alan Greenspan passed away this week at age 100. Having served in the role for 19 years, he had an outsized influence compared to many other chairmen. He famously used the phrase “irrational exuberance” to describe the frothy stock market in the late 90s during the dot-com bubble. A bubble that would ultimately pop several years later.

Coincidentally, I was already working on a column about the concept of “irrational exuberance” as many people have been suggesting what we are living through now feels very similar to the late 90s dot-com bubble. Naturally, when people hear valuations are close to where they were during the dot-com bubble and subsequent crash they want to abandon their investments until after an “inevitable” crash occurs. But is that a good idea?

I think it is helpful to look back to December 5, 1996 when Greenspan gave his speech about “irrational exuberance” for perspective. The S&P 500 index closed that day at 744.38. It would proceed to rally over the next several years before peaking at 1,552.87 on March 24, 2000. Investors who bailed out when Greenspan made his comments missed out on their portfolio doubling in the short-term.

But of course, the bubble was about to pop. When it did stocks came tumbling down in spectacular fashion. But I think it is important to note, the S&P 500 index never fell back to the price it was when Greenspan made his comments. It came close, but never fell so far as to produce a negative return for people who stuck with an S&P 500 portfolio after hearing his comments.

Looking at the long term, almost 30 years later the S&P 500 index is now hovering around 7,500. It is roughly 10 times higher than it was when Greenspan gave his speech. That increase in price also doesn’t fully capture the returns investors received, as they would also have received (and possibly reinvested) dividends over those three decades.

Even in the face of a market we suspect is over-stretched as far as valuations, the best option for investors is to continue to buy and hold. Though the market may have been experiencing “irrational exuberance” in late 1996, I think we would all like to go back and buy when the S&P 500 was at 744. I think we will feel the same way looking back on today’s prices 30 years from now.

Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.