Over the last couple of decades, the International Center for Finance at Yale University has regularly surveyed both individual and institutional investors and asked them about their views of the market. There are four major questions: one year confidence, buy-on-dips confidence, crash confidence, and valuation confidence. We’re going to focus on two of those today: “one-year confidence” and “valuation confidence”. One-year confidence is the percent of investors expecting a positive return for the Dow Jones Industrial Average over the next year. Valuation confidence is the percentage of investors who are confident in the valuation of the market, meaning they think the market is valued either too low or about right. The confidence indices are shown for both individual investors and institutional investors, and we highlight charts of the two readings below.

As you can see in the “One-Year Confidence” chart, according to Yale’s survey, investors have gotten crazy bullish on stocks over the last few months. Institutional investors are extremely bullish: less than 2% don’t expect gains for the Dow over the next year! Individual investors are the most bullish since February 2004, when 93.4% expected gains. Currently, over 90.9% expect further gains.

While investors are crazy bullish on the market over the next year, they aren’t attracted to the market’s valuation. As shown in the second chart below, a historically low share of investors think the market is cheap; Valuation Confidence from both individual and institutional investors is near the lowest levels on record.

So what do you call high confidence that the market will be higher a year from now while at the same time not liking the valuation of the market? Some would say “irrational exuberance.” We decided to create an “irrational exuberance” indicator from this survey data which is simply Valuation Confidence subtracted from One Year Confidence. As shown below, this reading has exploded higher recently for both institutional and individual investors.

The chart below only shows the combined “irrational exuberance” indicator based on the average of the institutional and individual investor readings. When the reading is positive, it means confidence that the market will be higher one year from now is higher than confidence in the valuation of the market. The opposite is the case when the reading is in negative territory.

The key takeaway from our combined “irrational exuberance” indicator is that investors think simultaneously that the market is over-valued but likely to keep climbing: that’s the exact phenomenon famously described by former Fed Chair Alan Greenspan in a December 1996 speech. Robert J. Shiller, the originator of the Yale Investor Confidence series, is rumored to have first invented the term; he later wrote a book with the same title.

While the Yale Confidence series aren’t a very good short-term market-timing tool, we can say that lower readings on our “irrational exuberance” indicator generally come at lower levels of the market. As shown above, the low of the reading came just after the lows for the market during the Financial Crisis. We also think that as a general proposition, if a huge share of investors think that the market is expensive but are still optimistic, the market’s psychology is fragile.

Equity valuations are not as extended now as they’ve been in true bubble territory (the tech bubble). That said, we do think this reading should make investors a bit cautious given that so many expect gains despite having little conviction in valuations.

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