The 'Irrational Exuberance' Of 1996, And How You'll Know It Has Returned

"Irrational Exuberance," the phrase made popular by former Fed Chairman Alan Greenspan has come to haunt the markets once more. The markets have been on an extended rally, in place since the economy exited the Great Recession in 2009.

Rampaging Bull

Officially, the recession ended in June 2009 and the rally commenced slightly before that. The bull market, therefore, is eight years old, affording it the status of the second longest in modern history (post-World War II). While this current bull market is impressive, it falls in second place — the winner being the 9.5-year run-up rally to the dot.com bubble burst in the 2000s.

Source: Y Charts

Since the rally started in March 2009, the S&P 500 has been up roughly 238 percent. The NASDAQ Composite has been up 344 percent. A bull market is defined as one which is seeing an extended sustained uptrend, without experiencing a pullback of over 20 percent.

In terms of the percentage of gains, the current bull market is holding at No. 3, following the dot.com rally and the run-up seen between June 1949 and August 1956.

The Debut Of The Phrase

Greenspan was the first to use the phrase "irrational exuberance" in his famous speech on Dec. 5, 1996, as an explanation for the excessive run-up in prices of certain assets at that time. The speech, titled "The Challenge of Central Banking in a Democratic Society," was delivered at the Annual Dinner and Francis Boyer Lecture of the American Enterprise Institute for Public Policy Research, Washington, D.C. Subsequently, Yale professor Robert Shiller used the phrase the title for his book in 2000, which predicted the dot.com bubble burst.

Economy Goes Boom Boom In 1990s

The U.S. economy experienced a protracted period of prosperity in the 1990s, with the economy expanding continuously for about 10 years following a recession that ended in March 1991. The good times lasted until March 2001, when the another recession masterminded by the bursting of the dot.com bubble took over. The period boasts of the distinction of being the longest expansion in the U.S. history.

Source: Y Charts

After recovering from the recession in the early 1990s, real GDP rose 3.1 percent in the second quarter of 1991. Between then and the second quarter of 2000, GDP growth averaged at an above-trend 3.8 percent, with growth peaking around 7.8 percent in the second quarter of 2000.

The unemployment rate, which was around 5.4 percent at the start of 1990 dropped below 4 percent by the year 2000. The cumulative job gains during the decade were 23,672,000. Monetary policy during the period was extremely accommodative.

The Federal Reserve lowered rates to 3 percent in 1992 in a bid to reinvigorate an economy convalescing from a recession. Although rates did climb subsequently, as the economy picked up steam, the Fed kept it low through the decade to ward off the impact of some global financial crises (Mexico in 1995, Asia in 1997, Russia in 1998 and Argentina in 1999) that shook the global economy.

Source: Y Charts

Rally Was On Despite Warning Of Irrational Exuberance

The rally stayed its course for a little over three years — from the time Greenspan broached the possibility of irrational exuberance to stocks peaking in early 2000. The rally was of course interspersed by corrections, defined as a pullback of at least 10 percent from recent highs. The notable pullbacks happened in the middle of 1998 and 1999.

Déjà Vu

For those who may not have had a hands-on experience with the bull run in the 1990s, just reading about it could instill an eerie feeling; since 2009, stocks have been rallying.

Since the economy emerged out of a recession in June 2009, the U.S. economy had grown at an average rate of a little over 2 percent, which is now considered the new normal. In the intervening period, the economy experienced negative growth in the March quarter of 2011 and the March quarter of 2014.

Source: Y Charts

From a post-recession peak of 10 percent in October 2009, the U.S. jobless rate has fallen steadily and is at 4.7 percent currently.

After bleeding jobs in 2009 and for a few months in 2010, the economy began a streak of positive non-farm payroll gains since October 2010. Since then, the economy has added 206,000 jobs, on an average, recording cumulative gains of 15,913,000.

The monetary policy environment has also been accommodative, with the Fed slashing rates to zero percent in December 2008. The fed funds rate has remained at zero until December 2015, when the rate was bumped up by 0–0.25 percent. Subsequently, there was a quarter basis point increment in December 2016 and another of the same magnitude in March 2017. The rate is now at 0.50–0.75 percent.

Trump Election Gives Market Another Leg Up

The current bull market gained a further leg, with the election of Donald Trump as the president of the United States. Since November 2016, the S&P 500 Index is up 11.42 percent and the Nasdaq Composite has gained 13.78 percent, with the latter trading slightly shy of the all-time closing record.

After hitting 20,000 following Trump's inauguration, the Dow Jones Industrial Average 2 Minute has scaled the next psychological barrier of 21,000 in less than a month. It is currently trading off this high.

The pro-business promise of Trump and the "Make America Great Again" slogan touted by the then-candidate during his election campaign seem to have done the trick. The president has promised to pursue protectionists policies, to revamp the sagging domestic manufacturing sector by bringing back production and jobs to the United States, to remove regulatory bottle necks and to implement tax reforms, among other promises.

"Given political fluidity and the myriad of economic appointments and issues in play, it is hard to predict how long this phase will persist and how noisy it will be. The direction of the subsequent breakout is also hard to specify at this stage because of competing drivers that also extend beyond the U.S," a Seeking Alpha article said, quoting Mohamed El-Erian.

"[P]ro-growth policy announcements would need to give way to detailed careful design and, with the administration working collaboratively with Congress, sound implementation."

El-Erian feels the sustenance of the rally or snapping of the rally would also depend on improvements elsewhere, particularly in China, Europe and Japan. Otherwise, a consequential appreciation of the dollar poses a significant headwind to corporate performance and fuel protectionist forces within the United States, he added.

Thus, action seems to be key, as the Trump administration has to walk the talk to instill investor confidence in the potential for further upside.

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