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Irrational Exuberance: Deja-vu All Over Again?

By Curtis Lang on Apr 22, 2000

This article originally appeared in OnMoney.com, a division of the online broker Ameritrade.

Irrational Exuberance: Déjà-vu All Over Again?

"Slump? I ain't in no slump. I just ain't hittin," explained famous philosopher, Hall of Fame ballplayer, and pennant-winning Manager (for the both the Yankees and Mets), Lawrence "Yogi" Berra, when asked about a long dry spell at the plate.

He could have been speaking for the equity markets' hivemind this week. The Nasdaq composite is off more than 53% from its high reached less than one year ago. After a big January pop, the COMP ended the month 46% off its March 2000 peak, and then proceeded to lose another 16% from its January 31 level.

Individual investors, who led the bull market charge in the 1990s, and who were consistently more upbeat than institutional money managers during the Clinton boom, have grown skittish. But the pros on the Street shrug off all the bad news, in the manner of the great Yogi.

The market for options on individual stocks is throwing off bearish indicators, and that is the market of choice for individual investors. Meanwhile the stock index options market, used mainly by professional money managers, is sending bullish signals.

Meanwhile, a parade of academics and economists have suggested recently that this decline is not the result of a world-class speculative bubble bursting, but rather a safe and sane return to rational valuations for tech stocks – and so there will be no long term negative effects from what has been an unpleasant but transient plunge in the Nazz. We are set to see a V shaped recovery, thanks to the magic of Alan Greenspan and the stock markets will, for once, follow the economy into a stable recovery. As we all know, the last ten years have seen the economy follow the tech stocks up. Consumers and individual investors are well-conditioned to believe that as tech stocks go, so goes the economy – and their retirement nest eggs.

It's true that the economy, while depressed from boom levels, still has not entered into recessionary territory. But after such a prolonged period of sizzling growth, a slower economy feels like a disaster. And with returns from tech stocks and the twin stock indices now flat to negative, consumer confidence is in the tank. That's another reason individual investors have pulled in their horns.

But the big question remains, which way is the Nazz going next? Buy and hold sounds good, but if the markets must endure more water torture, and if we are not now seeing a bottom in the tech sector, most individual investors won't have the patience to wait a year or two while their retirement accounts slowly bleed away.

Bears such as Robert Schiller, who predicted the bursting of the bubble in his book Irrational Exuberance , have said that they believe tech stocks must return to their historical price-earnings ratios, somewhere around the mid-twenties.

As we all know, stocks like Cisco CSCO , Schwab SCH , AOL-Time Warner AOL , JDS Uniphase JDSU , and Microsoft MSFT , have not yet retreated to those levels. More significantly, price-to-earnings ratios for Nasdaq stocks have actually increased, although prices have plummeted, because earnings have fallen even faster than stock prices during this stomach-churning nose-dive. The price-to-earnings ratio for stocks in the Nasdaq 100 index now stands at a breath-taking 811 to 1, according to a recent article in The New York Times.

So are the brains behind the big portfolios ready to take a deep breath, reflect and park their stash in cash until they see evidence of an outbreak of sanity in this still-overheated atmosphere? Don't worry about that.

The best and brightest on the Street have definitely not turned negative. Far from it. The average stock allocation by Wall Street gurus has been 68% or 69% this year, according to Schaeffer's Investment Research, Inc., which points out that average stock allocations were only 61% in March 2000 at the height of the Nasdaq bull run. The only thing this market decline has done for these folks is turn them more bullish.

Ditto the newsletter writers polled weekly by Investors Intelligence. The most recent poll stands at 57.8% bullish. Just one week ago, the poll was at 61.8% bullish. This was the most bullish sentiment in over fourteen years.

Can anyone say the word "capitulate"? Does anyone still believe that market bottoms and bull market fever do not go hand in hand? During the Nineties, the individual investors were right to plunge into the bull market wholeheartedly, and the pros who lagged behind failed to keep up with them. Who will be right today and tomorrow? The folks who implemented the individual investor revolution or the suits who run the big portfolios?

Will past be prelude to the future or are we in a new world where the wisdom of the Nineties belongs in the traschcan of history?

Are the money managers now in the grip of irrational exuberance? Or are individual investors losing their spinal fortitude?

It's pretty hard to tell.

As for me, I'm taking the Yogi's wisdom very seriously.

"You got to be very careful if you don't know where you're going," Yogi explained. "Because you might not get there."