Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?
The market is gyrating a bit, and that's natural for the kind of run experienced over the past five years, but the growing chorus of bubbles and crashes make normalcy more unnerving. This harkens back to the famous (or infamous) irrational exuberance comments from Alan Greenspan. Back in December 1996, the Federal Reserve chairman uttered this statement that sent the market lower for a moment before those same animal spirits he was trying to corral went back into a buying frenzy.
When Greenspan made his observation, the Dow Jones Industrial average was 6,400, up more than 170% from the start of that bull market back in October 11, 1990 (the index was up 269% from the low of Black Monday 1987).
The Hungry Bears
By the time the rally ran its course in March 2000, the Dow had climbed to 11,723, or 392% in a single decade. The rally proved a few things including that true insanity in the stock market reaches unfathomable levels well beyond anything we're seeing today. In fact, the craziness gets so perverse that 98% of naysayers either jump on the bandwagon or temper their frustration and fear. At this point, the bears are growling with confidence, but most are just guessing and nudging.
For many, it doesn't matter if the correction (long overdue) happens soon or months from now, they've positioned themselves to try to reclaim influence. For bears and shorts, it's always much better when they can jawbone a stock or even the broad market lower as timing has never been their specialty. In the meantime, most have missed the rally, and this is how they (A) try to make some money and (B) try to save face.