The Malta Independent
Just when the US and international stock markets were reaching the peak of their meteoric rise in the spring of 2000 Professor Robert Schiller published his now epic book `Irrational Exuberance` where he predicted that the market `had become dominated by unrealistically optimistic expectations that were driving share prices to a level totally detached from their intrinsic values. Schiller confidently and correctly predicted that the market will undergo a wild self-correction to bring equity prices more in line with their underlying reality and it will be a painful exercise spanning many years before the markets can regain such peaks in an orderly and sustainable manner.
The phrase Irrational Exuberance was originally attributed to Federal Reserve chairman Alan Greenspan who in 1996 coined it to express his uneasiness with the then perceived high level of equity prices. Greenspan is in fact often criticised why he publicly expressed his feelings about irrational exuberance in the market in 1996 and then kept expressing confidence in 1999/2000, when prices went way over the top, that their then inflated `valuations possibly reflected the tremendous efficiency gains that applied technology was delivering.
Schiller on the other hand claims copyright for the Irrational Exuberance term saying that he used it during his various private conversations with Greenspan.
But more importantly for us than who is the rightful inventor of the phrase, it is whether the local stock market is currently undergoing a fresh bout of such irrational exuberance. Last week the Malta Stock Exchange Index closed just under 3000 which gives it 38% up for the year, 60% up for 2 years and 52% up for 5 years.
Five years ago this time was the start of the extreme irrational exuberance cycle and one therefore should rightly query whether the continued strength of equity prices during the current week has in fact landed us in such slippery territory.
One of the equities mostly contributing to this position is that of Bank of Valletta. The share price closed at Lm4.75c0 on Wednesday being 13.6% up from last week`s close and 85% up from its end of 2003 value.
At Lm 4.75 Bank of Valletta `s share price is very very close to its 2000 all time peak of Lm5.80 which for comparison purposes should be adjusted down to Lm4.83c0 to account for the one in five bonus shares issued since then.
If this level proved to be irrational in 2000 what circumstances could justify it in 2004 or is it simply a case of short memories and quick return to a state of irrationality`
Price bubbles are obviously much easier to identify in hindsight.` We can now positively ascertain that the 2000 equity prices where unjustified, unsustainable and detached from reality but in those get rich quick days the existence of the bubble was less visible, obfuscated as it was with great expectations for future profit growth and the inevitable momentum of the market. There were few exceptional characters like Schiller who had the courage to call a bubble by its true name.
In contrast with international equity prices that seem too cautious to shake off the post-bubble pain and are demanding solid not just isolated evidence of sustained corporate profitability growth before crawling forward anywhere near their 2000 peaks, locally we are now very much rushing versus a year 2000-like situation.` What criteria can we use to distinguish whether equity prices are justified by actual past experience and` fair future expectations, or whether we are dangerously in unsustainable irrational exuberance territory`
Time will be the best judge, `but consider this. Nothing much has actually happened so far which could justify an 85% increase in Bank of Valletta`s share price since last December. The 6 months interim results published in spring for the current financial year do not on their own justify such price explosion. This week`s further price notch up can be directly related to the announcement that government and Banco di Sicilia have reached agreement to offload their joint 40% stake in Bank of Valletta to a strategic partner. This in itself was hardly a new development as government has long been making it public knowledge that it means to divest its remaining stake in Bank of Valletta.
At Lm4.75c0 Bank of Valletta `s share price is trading at 25 times last year`s earnings per share.` Internationally the price earnings ratio for the financial sector would average anything between 10 and 15 with 12.5 being a fair overall average. This means that for the price earnings ratio of Bank of Valletta to come back within international averages that a strategic partner would expect to pay for such acquisition, the Bank would have to announce a 100% increase in its profit for 2004 over 2003.` Unlikely to say the least!
There is no clear logic in equity pricing and share prices have been known to deviate from their true underlying value quite widely and extensively. There is no assurance that the momentum of irrational exuberance will not push Bank of Valletta share price and the Malta Stock Exchange index higher further away from reality.` This does not however negate my view that at least in case of Bank of Valletta, the share price is being driven by irrational exuberance and illogical analogies from the experience of past privatisations.
Just when the US and international stock markets were reaching the peak of their meteoric rise in the spring of 2000 Professor Robert Schiller published his now epic book `Irrational Exuberance` where he predicted that the market `had become dominated by unrealistically optimistic expectations that were driving share prices to a level totally detached from their intrinsic values. Schiller confidently and correctly predicted that the market will undergo a wild self-correction to bring equity prices more in line with their underlying reality and it will be a painful exercise spanning many years before the markets can regain such peaks in an orderly and sustainable manner.
The phrase Irrational Exuberance was originally attributed to Federal Reserve chairman Alan Greenspan who in 1996 coined it to express his uneasiness with the then perceived high level of equity prices. Greenspan is in fact often criticised why he publicly expressed his feelings about irrational exuberance in the market in 1996 and then kept expressing confidence in 1999/2000, when prices went way over the top, that their then inflated `valuations possibly reflected the tremendous efficiency gains that applied technology was delivering.
Schiller on the other hand claims copyright for the Irrational Exuberance term saying that he used it during his various private conversations with Greenspan.
But more importantly for us than who is the rightful inventor of the phrase, it is whether the local stock market is currently undergoing a fresh bout of such irrational exuberance. Last week the Malta Stock Exchange Index closed just under 3000 which gives it 38% up for the year, 60% up for 2 years and 52% up for 5 years.
Five years ago this time was the start of the extreme irrational exuberance cycle and one therefore should rightly query whether the continued strength of equity prices during the current week has in fact landed us in such slippery territory.
One of the equities mostly contributing to this position is that of Bank of Valletta. The share price closed at Lm4.75c0 on Wednesday being 13.6% up from last week`s close and 85% up from its end of 2003 value.
At Lm 4.75 Bank of Valletta `s share price is very very close to its 2000 all time peak of Lm5.80 which for comparison purposes should be adjusted down to Lm4.83c0 to account for the one in five bonus shares issued since then.
If this level proved to be irrational in 2000 what circumstances could justify it in 2004 or is it simply a case of short memories and quick return to a state of irrationality`
Price bubbles are obviously much easier to identify in hindsight.` We can now positively ascertain that the 2000 equity prices where unjustified, unsustainable and detached from reality but in those get rich quick days the existence of the bubble was less visible, obfuscated as it was with great expectations for future profit growth and the inevitable momentum of the market. There were few exceptional characters like Schiller who had the courage to call a bubble by its true name.
In contrast with international equity prices that seem too cautious to shake off the post-bubble pain and are demanding solid not just isolated evidence of sustained corporate profitability growth before crawling forward anywhere near their 2000 peaks, locally we are now very much rushing versus a year 2000-like situation.` What criteria can we use to distinguish whether equity prices are justified by actual past experience and` fair future expectations, or whether we are dangerously in unsustainable irrational exuberance territory`
Time will be the best judge, `but consider this. Nothing much has actually happened so far which could justify an 85% increase in Bank of Valletta`s share price since last December. The 6 months interim results published in spring for the current financial year do not on their own justify such price explosion. This week`s further price notch up can be directly related to the announcement that government and Banco di Sicilia have reached agreement to offload their joint 40% stake in Bank of Valletta to a strategic partner. This in itself was hardly a new development as government has long been making it public knowledge that it means to divest its remaining stake in Bank of Valletta.
At Lm4.75c0 Bank of Valletta `s share price is trading at 25 times last year`s earnings per share.` Internationally the price earnings ratio for the financial sector would average anything between 10 and 15 with 12.5 being a fair overall average. This means that for the price earnings ratio of Bank of Valletta to come back within international averages that a strategic partner would expect to pay for such acquisition, the Bank would have to announce a 100% increase in its profit for 2004 over 2003.` Unlikely to say the least!
There is no clear logic in equity pricing and share prices have been known to deviate from their true underlying value quite widely and extensively. There is no assurance that the momentum of irrational exuberance will not push Bank of Valletta share price and the Malta Stock Exchange index higher further away from reality.` This does not however negate my view that at least in case of Bank of Valletta, the share price is being driven by irrational exuberance and illogical analogies from the experience of past privatisations.
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