Are Stock Markets Irrationally Apprehensive?

The DJIA avoided re-crossing Yellen’s irrational exuberance flash-point of 6437 today, but it seems only a matter of short time before that happens. Many would argue that investors are as irrational now as then, but consider this. From August 12, 1992, the start of a bull mark when the DJIA was at 777, to 6437 now would represent a per annum advance of 8.3% over roughly 36-1/2 years. U.S. real economic growth over such a period averaged 3.1% per annum.

Over the very long run, one would expect the share of GDP represented by profits to hold reasonably steady and stock prices to move in line with profits. The discrepancy between appreciation in the DOW and real GDP growth cannot be fully explained by prices. Consumer prices during this period went up 3.0% per annum. Since share-holders also received dividends, a rise from 777 in August 1992 to 6437 in March 2016 doesn’t appear unreasonable, let alone irrational. Only when one knows that the market has dropped from a high as 14165 in merely 17 month do present levels look irrational. That’s what boom-bust cycles are about. The higher one flies, the harder the fall.

October had uncanny parallels to September. Most of October had seen a rise in risk appetite and associated weakness in the dollar and strength in equities, and in most of November just the opposite had occurred. Former Greek Prime Minister Papandreou’s proposal to submit the October 26 EU rescue package to a referendum caused that month’s market moves to be substantially reversed on the final day of October, and the announcement of coordinated action by six central banks today likewise trimmed a large portion of market movements that had occurred between September 31 and October 31.