Irrational Exuberance and Twitter shares

Tom White

20th October 2013

 I just love the phrase 'irrational exuberance'. It's the title of book by Robert Shiller who has just won a Nobel Prize in Economics. But the phrase was coined by the US Federal Reserve Board Chairman, Alan Greenspan, in a speech given at the American Enterprise Institute during the Dot-com bubble of the 1990s.

 I will make no attempt to tackle the complex issues that these top Economists were articulating, and instead give a few examples to convey the basics: it's just not safe to assume economic agents are always making rational choices based on transparent, accurate information.

There are some good examples in a recent Economist article. Shares in Tweeter, a bankrupt electronics retailer, briefly soared 1,800% because some investors mistook its ticker symbol TWTRQ for TWTR. Even though Twitter shares aren't available to the public (yet) and when it does list, the issue price is highly unlikely to be a few cents. This was just a daft mistake.

This seems to attack the idea of an efficient market, in which prices are set by rational investors in command of all pertinent public information. The dotcom boom of the late 1990s (the source of the Alan Greenspan quote) contained some classic examples of investor irrationality, according to the article. Companies could add millions to their market value merely by adding the letter “e" to the start of their name, even though they had no coherent internet strategy. 3Com, an electronics company, floated a stake in its subsidiary Palm, a maker of hand-held computers; its remaining holding in Palm was soon worth more than 3Com itself. In other words, investors were applying a negative value to the underlying business of 3Com, which was profitable at the time. The discrepancy persisted for months. Sensible fund managers who stood aside from the dotcom foolishness even lost clients and eventually their jobs as a result.

To be fair, there is great uncertainty about the future value of internet businesses, like Facebook. Take Twitter itself. It may still be losing money but its revenues are growing rapidly: $253m in the first half of the year, up from $317m in the whole of 2012. How long can such doubling of revenues last? Two years? Ten years? No price for the shares has yet been set but an indicated value of $9.7 billion for the whole company is mentioned, or more than 21 times the group's revenues for the past 12 months. It may not be irrational to buy shares in the group but it certainly requires a degree of optimism. You will appreciate the central importance of confidence to the economy, and its significance in driving stock market booms and busts.

(an update to this bog is a link to fantastic BBC article by Tim Harford & Ruth Alexander)

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