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Irrational Exuberance

Precipitating Factors - The Internet, The Baby Boom, And Other Events

The remarkable surge in the value of the stock market - since 1982 caused the price-earnings ratio to pass its former high record set in September 1929. It is insufficient to say that the market in general is vulnerable to irrational exuberance.


Owing to a market's ability to respond appropriately to such factors as - growth in earnings, or change in real interest rates - that the well-functioning financial markets promote rather than obstruct economic efficiency.


The precipitating factors that exist in the background of the market include:- 


1) THE ARRIVAL OF THE INTERNET AT A TIME OF SOLID EARNINGS GROWTH: The internet and the World Wide Web have become a categorically significant part of our lives since the 1990s. The occurrence of profit growth simultaneously with the appearance of a new technology i.e, the Internet easily created the impression that the two episodes were in a way connected. The effect of new technology on the existing companies could either boost their profits or reduce them remarkably. What is actually important for a stock market boom is not the reality of the Internet revolution but rather the public impressions that the revolution creates.


2) TRIUMPHALISM AND THE DECLINE OF FOREIGN ECONOMIC RIVALS: Confidence in the former capitalist system has transformed into confidence in the market, the US stock market being the most prestigious. Triumphalism is associated with feelings of patriotism. Popular slogans used during the bull markets of 1920 were "Be a Bull on America" and "Never sell the US short".

3) CULTURAL CHANGES FAVOURING BUSINESS SUCCESS OR THE APPEARANCE THEREOF: The bull markets have been followed by a considerable rise in materialistic values. Such values often influence people's demand for stocks. The idea that investing in stocks is the path to quick riches has a certain appeal to materialists. A key factor in the decline of labour unions is the erosion of solidarity and loyalty among the workers.


4) A REPUBLICAN CONGRESS AND CAPITAL GAINS TAX CUTS: The change in government of the United States in the 1980's boosted public confidence in the stock market. This was because of a variety of controls that the legislature can exert over corporate profits and investor returns. People were afraid to sell their assets even at appreciated rates fearing capital gains taxes.


5) BABY BOOM AND ITS PERCEIVED EFFECTS ON THE MARKET: Soon after World War II there was a significant increase in the birth rate in the US. Progress in the birth control technology and the acceptance of the legality of contraceptions and abortions brought about a decrease in the rate of population growth. The Baby Boom and the subsequent Baby Bust have created an enormous crisis in many countries as the number of young people available to support the elderly will decline worldwide.


The Baby Boom theory fails to consider 'when exactly' the Baby Boom should affect the Stock Market. People of different age groups have age-related differences in risk-tolerance. The stock market is relatively high now because the people in their forties are naturally less risk averse than older people. Public perceptions about Baby Boom and its presumed effects are seemingly more responsible for the surge in the market.


6) AN EXPANSION IN MEDIA REPORTING OF BUSINESS NEWS: The first news television station, CNN appeared in 1980 and gradually grew. The Financial News Network was later absorbed into CNBC. These networks together produced an uninterrupted stream of financial news, related to the stock market. Such enhanced business reporting led to increased demand for stocks.

7) ANALYST'S INCREASINGLY OPTIMISTIC FORECASTS: Analysts are now reluctant to provide recommendations to investors to sell anything. A sell recommendation can quite possibly incur the wrath of the company involved. An increasing number of analysts are also employed by firms that underwrite securities The analyst's quantitative forecasts of earnings growth show an upward bias.


8) THE EXPANSION OF DEFINED CONTRIBUTION PENSION PLANS: Changes over time in the employee pension plans have incentivized people to accept stocks as investments. By offering multiple stock market investment categories for employees to choose from, employers can create demand for stocks. The interest / curiosity value of stocks encourages investors to buy more of them. And this apparently unconscious interest has helped bid up the price of the stock market.


9) THE GROWTH OF MUTUAL FUNDS: The boom in the stock market has coincided with a boom in the mutual fund industry as well. Part of the reason that equity mutual funds proliferated is that they are used as a part of pension plans. Another reason is that they have paid for a great deal of advertising. The popular concept that mutual fund investing is sound, convenient and safe has encouraged many non-investors to come forward and join the market.


10) THE DECLINE OF INFLATION AND THE EFFECTS OF MONEY ILLUSION: High inflation is perceived to be a sign of economic disarray. Low inflation is viewed as a sign of economic prosperity and social justice. A decreased inflation rate boosts public confidence, and in turn the stock market valuation. Public confusion about the effects of a changing monetary standard is referred to as "monetary illusion".


11) EXPANSION OF THE VOLUME OF TRADE - DISCOUNT BROKERS, DAY TRADERS, AND TWENTY-FOUR HOUR TRADING: A higher turnover rate may be symptomatic of increased interest in the market. Another reason for the rising turnover rate is the declining cost of making a trade. The development of online trading and the opening of markets for extended hours led to heightened volatility.


12) THE RISE OF GAMBLING OPPORTUNITIES: The pervasiveness and convenience of gambling opportunities and the strength of the marketing campaign undertaken to promote gambling are unmatched in US history. The rise of gambling institutions and the increased frequency of actual gambling have increased risk taking in other areas, like investing in the stock market.

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