During the election campaign, much attention was focused on the evils of inflation. I agree that inflation is bad. It’s a deception. Inflation makes everybody poorer (because they cannot buy as many goods and services) while they still earn as much income in a nominal sense.
When people tolerate inflation, we get a lot of it. Politicians are always tempted to spend more without raising the taxes needed to finance the spending by just printing more dollars, and that, of course, causes inflation. The only way to stop this is for voters to be vigilant in opposing policies likely to cause inflation. However, only in unusual circumstances does inflation get so bad that the negative effect becomes evident dramatically. Small increases in inflation are usually met with complacency. So, the temptation for politicians to advance inflationary policies is just about ever-present.
That’s the story with irrational exuberance! There are so many similarities!
Irrational exuberance is another way to make people feel richer without actually doing so. Irrational exuberance gains are nominal gains. On a portfolio statement, they look just as good as real, economic-based stock-market gains. But of course, they are very different. They don’t last. They get the investor who believes in them in big trouble somewhere down the line.
They are a deception! That’s the thing. Inflation can make people feel like they are earning more because their wages increase. But if the cost of goods and services has increased at a greater rate, the worker is less able to save than he was before. Inflation possesses a hidden cost as does irrational exuberance. Not knowing the true value of your stock portfolio makes it impossible to engage in effective money management. Irrational exuberance is no more the investor’s friend than inflation is the consumer’s friend.
But irrational exuberance does have friends in high places every bit as much as inflation does. It’s not politicians who promote irrational exuberance. But investment advisers love it. When stock prices increase by more than the economic realities justify, people love stocks more than they should, and everyone who makes money selling stocks and stock advice benefits. So there’s always a temptation present to generate more of it. Hence, the relentless promotion of the Buy-and-Hold strategy posits that there is no need for investors to lower their stock allocation when high prices diminish the long-term value proposition of stocks.
The downside is that it is unclear and urgent enough for people to get too upset about it. Irrational exuberance can cause terrible life setbacks when it brings on a price crash and an economic collapse. I can recall hearing people express great anguish in the days following the crash of 2008. It didn’t occur to them that prices could fall that far and that fast. And, of course, there is nothing that can be done to get the money back once the losses are a reality. If you only listened to Buy-and-Holders, you would think that large stock losses are no biggie. But that’s not the story told by many of the investors who suffer from them.
Yet we remain complacent. The only way to keep irrational exuberance from getting out of control is to do daily battle with it. I would like to see every investing site make it a high priority to persuade investors to do something about today’s CAPE value. But of course, the only effective response would be for investors to lower their stock allocation. I know how the Buy-and-Holders would respond. That’s market timing!
I have been known to refer to irrational exuberance as the cancer of personal finance. Thinking that one over makes me feel more charitable toward the inflation phenomenon.
