Trend following amid irrational exuberance

ON DEC 5, 1996, Alan Greenspan, then chairman of the Federal Reserve, first used the phrase “irrational exuberance” in a speech to warn investors that the stock market could be overvalued and about the ensuing consequences.

Greenspan said: “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? And how do we factor that assessment into monetary policy?”

Despite his stern warning, the US stock market rallied strongly till early 2000. Investors who sold their stocks due to expensive stock valuation regretted selling too early. Those who shorted the stocks early also fared poorly. In the end, investors who “buy and hold” stocks after the “irrational exuberance” speech made good gains.