UPON BEING sucked into investing during the South Sea Bubble, Sir Isaac Newton reflected that he could "calculate the motions of the heavenly bodies but not the madness of people". From tulip mania in 17th-century Amsterdam to railway fever in Victorian Britain, history is littered with tales of investors who lost their heads shortly before they lost their shirts, in the grip of mass delusions described by Alan Greenspan, a former chairman of the Federal Reserve, as "irrational exuberance". These delusions seem obvious with the cold clarity of hindsight. Spotting them in real time, however, is trickier- especially when the usual measures of frothiness are out of action. Wall Street types typically pore over price-to-earn-ings ratios, which compare a firm's value with its profits, or free-cashflow measures, which look at the cash firms crank out after investment. Warren Buffett targets firms with a high return on capital, which compares their profits with the size of their balance-sheets. But the covid-induced economic slump has caused earnings to sink even as the Fed and other policymakers have helped buoy share prices. The obvious gauges of frothiness are not much use.
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