Irrational Exuberance
A state where asset prices swell far above real value, swept up in baseless optimism — the psychological foundation of a bubble.
In plain terms
Irrational exuberance is a state where "excitement rules the market over reason." Regardless of a company's real value, the price soars on the psychology of "others are buying, so I will too" and "it'll rise more."
In 1996, then-Fed chair Alan Greenspan used the phrase watching the dot-com frenzy — a warning that the market may be too excited. The bubble indeed burst a few years later.
What it tells you
This phrase is a warning that "price is straying from value." When everyone is optimistic and "this time is different" circulates is usually the most dangerous time.
Irrational exuberance is the psychological fuel of a bubble. It refers to a phase where people keep buying even as the numbers (valuation) say it is expensive.
Formula
irrational exuberance = an excessive price rise made by crowd psychology, unexplained by fundamentals (results, assets) (a phrase Alan Greenspan used in 1996)
What high or low means
When valuations (PER, PSR, etc.) run far above their historical averages yet optimism of "it'll rise more" rules, it reads as a sign of irrational exuberance.
But even when a warning of "overheating" comes, a bubble can swell much longer. The market rose for over 3 more years after Greenspan's warning. So overheating is not a tool for calling "timing."
Do not declare "it's overheated, so it'll fall soon." A bubble can go far higher and far longer than expected. Betting trade timing on overheating is risky (and so is getting swept up and hopping on at the tail end).
In hindsight "that was a bubble" looks obvious, but in the thick of it it is very hard to tell. So it matters to view it calmly together with the numbers (valuation).
In December 1996, then-Fed chair Alan Greenspan first used the phrase "irrational exuberance" in a speech about the heated market — a warning that it may be too excited beyond real value.
But the market, as if mocking the warning, rose for over 3 more years before collapsing as the dot-com bubble burst in 2000. It is a famous anecdote showing that even when the diagnosis of "overheating" is right, no one knows when it will burst.
Metrics to read alongside
See it in real stocks
Search US stocks on Stocklore to see Irrational and other financial metrics alongside the sector average.
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.