Irrational Exuberance and the Cinderella Syndrome

Irrational Exuberance and the Cinderella Syndrome / Dr. Mahfi Egilmez

Irrational exuberance describes a state of excessive optimism in which investors push the price of an asset far beyond its underlying or intrinsic value, largely ignoring economic and financial fundamentals. The phrase was famously used by then-Federal Reserve Chairman Alan Greenspan in a 1996 speech (1). It later became closely associated with the dot-com bubble, when valuations of internet and technology companies soared to levels that were difficult to justify by their underlying businesses.

Türkiye has experienced episodes that bear similarities to irrational exuberance. One recent example was the extraordinary investor enthusiasm surrounding initial public offerings (IPOs) in 2022 and 2023. Against a backdrop of high inflation and deeply negative real interest rates, large numbers of new investors turned to the stock market. Some newly listed companies saw their share prices rise sharply for days on end, in ways that appeared increasingly disconnected from their operations, profitability and financial fundamentals.

Social-media groups helped amplify the phenomenon. So did the stories of investors who had made substantial gains in a matter of days. The stock market suddenly became a subject of interest for a much broader segment of society, including many people who had never invested before.

As prices continued to rise, however, the price itself began to serve as a reason to buy. A stock attracted more attention because it was going up; greater attention pushed the price higher; and the rising price attracted yet more investors, many of whom were driven by fear of missing out, or FOMO.

This creates a more interesting question than simply asking why investors failed to recognize that prices had become excessive. Why do investors stay in the market even when they know they may be in a bubble?

Warren Buffett offered a memorable analogy in his 2000 letter to Berkshire Hathaway shareholders (2), comparing speculative markets to Cinderella's ball. Cinderella knows that the magic will end at midnight. She therefore has to leave before the clock strikes twelve.

For investors, however, there is a crucial complication: nobody knows when midnight will come.

Everyone may understand that a bubble will eventually burst. What no one knows is when. And that uncertainty creates a powerful temptation to stay in the game just a little longer.

A stock has risen from 100 lira to 150. Why shouldn't it reach 200? If everyone around you is making money, leaving the party early can feel less like prudence and more like missing an opportunity.

This is where FOMO becomes particularly powerful. An investor may fully recognize that prices are detached from fundamentals and still remain in the market because they believe they can get out before everyone else. The problem is that everyone else may be thinking exactly the same thing.

That may be one of the most powerful psychological traps in financial markets.

People who make perfectly rational decisions in their everyday lives can behave very differently when they begin making money quickly and seemingly effortlessly. Rising prices reinforce confidence. Greater confidence encourages investors to take on more risk. And higher risk can, in turn, fuel even more aggressive buying.

Everyone is watching the clock.

But Buffett's analogy contains one final, crucial detail: the clocks in the ballroom where everyone is dancing have no hands.

There is no way to know when midnight will arrive.

 

Notes:

(1) Alan Greenspan, The Challenge of Central Banking in a Democratic Society, 5 Aralık 1996, Federal Reserve. Federal Reserve – Greenspan'ın 1996 konuşması

(2) Warren E. Buffett, Chairman's Letter – 2000 Annual Report, Berkshire Hathaway, 28 Şubat 2001. Berkshire Hathaway – 2000 Chairman's Letter