Irrational Exuberance
A state in which asset prices are swept up in groundless optimism and swell far beyond their actual value — the psychological foundation of a bubble.
Irrational exuberance = an excessive price rise created by crowd psychology that fundamentals (earnings, assets) cannot explain (a phrase used by Alan Greenspan in 1996)
When valuations (PER, PSR, and so on) sit far above their historical averages yet optimism that prices will keep climbing dominates, it reads as a sign of irrational exuberance.
In plain terms
Irrational exuberance describes a market where excitement, not reason, is in charge. Regardless of a company's actual value, prices surge purely on sentiment — "everyone else is buying, so I will too," or "it'll go higher."
Alan Greenspan, then Fed Chair, used the phrase in 1996 while watching the dot-com frenzy. It was a warning that the market might be getting overly excited. Sure enough, the bubble burst a few years later.
What it tells you
The phrase is a warning that prices are drifting away from value. When everyone is optimistic and people start saying "this time is different," that is usually the riskiest moment.
Irrational exuberance is the psychological fuel of a bubble. It refers to the phase where people keep buying even though the numbers (valuation) say the multiples are stretched.
Formula
Irrational exuberance = an excessive price rise created by crowd psychology that fundamentals (earnings, assets) cannot explain (a phrase used by Alan Greenspan in 1996)
What high or low means
When valuations (PER, PSR, and so on) sit far above their historical averages yet optimism that prices will keep climbing dominates, it reads as a sign of irrational exuberance.
That said, a bubble can keep inflating for a while even after warnings of overheating. The market rose for more than three years after Greenspan's remark. So overheating is not a tool for timing.
Overheating does not mean a decline is imminent. Bubbles can run far longer and higher than expected. Betting on timing based on overheating is risky (and so is getting swept up and joining at the very end).
In hindsight it looks obvious that "that was a bubble," but in the middle of it, telling the difference is very hard. That is why bubbles usually get named only after they are over.
In December 1996, then Fed Chair Alan Greenspan first used the phrase "irrational exuberance" in a speech about the red-hot stock market. It was a warning that the market might be far more excited than actual values justified.
Yet the market climbed for more than three years afterward, as if mocking the warning, and only collapsed in 2000 when the dot-com bubble burst. It is a famous episode showing that even when a diagnosis of overheating is right, no one knows when it will pop.
Metrics to read alongside
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This explanation is for information and reference only and is not a recommendation to buy or sell any security. Investment decisions and their consequences are your own.