'Irrational exuberance' gauge suggests bubble fears

by Alexandra Semenova

Wall Street speculators have returned in full force: US stocks have snapped back from the throes of April’s tariff selloff, hovering near record highs, the pipeline of new SPACs is rebounding and Cathie Wood’s flagship fund is on a historic tear.

That’s sparked a swift jump in a Barclays Plc measure of the market’s “irrational exuberance” — a phrase coined by former Federal Reserve Chair Alan Greenspan for when prices exceed assets’ fundamental values. The one-month average on the proprietary gauge has swung back into the double-digits for the first time since February — reaching levels that have signaled extreme frothiness in the past.

The bank noted that the measure, which is calculated from derivatives metrics, volatility technicals and sentiment signals inferred from options markets, has historically averaged around 7%, but occasionally it peaks above 10% as during the Dotcom era of the late 1990s, and the meme-stock frenzy of 2021. The gauge currently sits around 10.7%, data compiled by Barclays show.

“Fundamentals have taken a back seat again as stocks with hot narratives are trading like lottery tickets,” said Dave Mazza, chief executive officer of Roundhill Investments. He points out sentiment gauges like relative strength readings and valuation multiples are once again looking extended. “That sets the stage for a sharp air-pocket on the next bad headline.”

Animal spirits have been revived on optimism that the US is making progress on reaching trade deals with key partners — or that President Donald Trump will at least postpone his July 9 tariff deadline. There’s also speculation the Federal Reserve will cut interest rates. The upshot is that stocks set a record high on Friday for the first time since February. 

Frothy Signals

Barclays sees abundant signs of froth, with listings of new blank-check companies in 2025 already surpassing the last two years combined. Meanwhile, Cathie Wood’s ARK Innovation ETF (ARKK) — a proxy for profitless technology firms — posted one of its best rallies in history, second only to the post-Covid surge. 

In the second quarter, Bitcoin-linked firms rallied 78%, while quantum computing shares climbed 69% and meme stocks advanced 44% — all volatile corners where investors are betting on future returns that may not materialize. A basket of highly shorted securities rallied 29%.

“Elevated readings of the indicator suggest that investors may be overly exuberant, which could lead to increased market volatility,” said Stefano Pascale, head of US equity derivatives strategy at Barclays.

Pascale described the exuberance measure, which the firm dubs its Equity Euphoria Indicator, as measuring the proportion of euphoric stocks within a universe of US equities that have liquid options. It correlates with other popular metrics that measure retail investing, such as the net debit position of margin accounts, which shows the amount of borrowed money for a trade.

Despite elevated levels, Pascale argues that bubbles are difficult to time and can expand for extended periods before correcting. As such, he recommends riding the wave for now and hedging with options to curb potential losses if things go awry.

Copyright Bloomberg News