|
Fools and Their Money |
September 2002
|
Excessive Exuberence
As we learned in high school economics, inflation is the rise in prices that results from an excess of cash chasing a limited number of goods and services. So, it amuses and depresses that so many on Wall Street and Main Street spent so much of the 1990s worried about the Fed taking on inflation for food, gasoline and sneakers, and cared nothing for the inflation in stock market prices.
Stock prices should only rise when the earnings from the company increase. The classic price-to-earnings ratio stated this very clearly. But under Clinton and Greenspan, stock prices soared (Greenspan, to be fair, called it "excessive exuberence.") much faster than earnings rose.
Of course, many baby-boomers were in their top earning years, the underlying economy was healthy, and buying shares looked good. So loads of retail investors poured their money in. And no one could remember a bear market.
What they didn't understand was that the stock market operates on the "Bigger Fool" principle -- that is, one buys stock in the hope that there is a bigger fool out there prepared to pay one a premium when one decides to sell out. The problem arises when one is the biggest fool -- and no one is prepared to buy one's shares at inflated prices.
For those who got out at the top, congratulations. For everyone else, the next time you hear investment advice that is too good to be true, remember that it probably is.