Why Bubbles Happen
In late 1996, Alan Greenspan used the phrase irrational exuberance, and the words traveled across global markets almost instantly. Prices dropped because those words captured something investors already sensed but did not want to admit. Markets are not driven by calculation alone. They are shaped by excitement, envy, fear of missing out, and the tendency to treat rising prices as proof that something important must be true.
A speculative bubble forms when rising prices create their own justification. People see others making money, hear stories about a brighter future, and begin to believe that buying now is the only sensible choice. The higher prices go, the more convincing those stories sound. This spreads from person to person until enthusiasm itself becomes the main force pushing prices upward.
One useful way to judge whether stocks are overpriced is to compare prices with earnings over a long stretch of time, not just a single strong year. When prices rise far above the profits companies actually produce, future returns have usually been weak. Similar extremes appeared in 1901, 1929, and 1966. Each time, investors heard confident claims that the economy had changed so much that old standards no longer mattered.
These booms are tied to animal spirits, the human impulses that influence decision-making under uncertainty. Even experts struggle to separate real progress from crowd excitement when prices keep setting records. People often treat the market as if it has special wisdom about the future. In reality, it often reflects the emotions of the moment more than a sober view of long-term value.
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