"Irrational Exuberance" is Back

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The similarities of my early experiences with the Stock market continue to appear for me as I view the price action as of late. It quickly reminds me of the former Federal Reserve Chairman's Alan Greenspan now infamous speech when he mentioned the markets experiencing "irrational exuberance." Interestingly enough, when asked these days of the same concept when looking at valuations, the Fed and its representatives actually say they see no bubbles in any asset class! However, it leads me to wonder if we can ever call a bubble before it happens?

Measures of value change overtime as the many models themselves have changing assumptions and variables. Many depend of future expectations of cash flows or of potential supply/demand imbalances which themselves are uncertain. However, one of the underlying important assumptions are almost always macroeconomics views. How sustainable could the economic rebound really be? Will all sectors experience the same rebound? I am of the camp that believes that while some will rebound rather strongly, the dynamics of many industries and companies will be forever changed which will lead to changes in their free cash flow and capital needs.

This uncertainty is what I believe is not priced into the current financial markets. As many of these uncertainties can have domino like effects into the economy and markets, I believe risk itself is underpriced. This leads me to believe that valuations remain too high for the likelihood of performance over the next couple of years. The amount of economic growth needed to produce the growth in earnings implicit into the market is too large to not consider uncertainties. So, I come to think about what happens when "irrational exuberance" occurs in hindsight; markets go lower...

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