- A frothy market describes conditions where stock prices artificially increase based on market sentiment, not business fundamentals.
- Excitement and novelty are key drivers of market froth, as people invest because of fear of missing out on an opportunity to make money.
- When demand becomes too much to bear, frothy markets can lead to bubbles that eventually burst.
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Wall Street is filled with all kinds of jargon that you’re likely to hear in news reports or conversations but might not fully understand. One such term you’ve probably heard is “frothy market.”
What is a frothy market?
When you think of the word froth, you probably envision something like the foam that rises to the top of a mug when the beer in it is sloshed around, or the dessert recipe with instructions to whisk egg yolks and sugar into a froth.
In markets, froth is when investors get whipped up into such a frenzy that they ignore fundamentals and drive stock prices well past their intrinsic value.
“Market froth occurs when there is excitement over the development of new technologies or new products,” says Dan North, chief economist at Euler Hermes North America. “Such developments tend to make investors feel like they are getting in at the bottom floor of the next great thing, or getting a once-in-a-lifetime chance to ‘get rich quick.’ This compels investors to think that they have to buy now before anyone else hears about it, driving the price up.”
Frothy markets are highly volatile and unpredictable. The increase in prices they produce is also unsustainable. Froth often leads to market bubbles, which as history has shown eventually burst, devastating to investors and derailing the economy.
While the concept has been around for a long time, the term market froth was popularized on Wall Street around 2005, when Federal Reserve Chairman Alan Greenspan described local housing markets in the US as showing “signs of froth,” but that a ‘bubble’ in home prices for the nation as a whole” was unlikely. He got the froth part right. But Greenspan’s prediction about a bubble in home prices proved incorrect within a few years, when mortgage companies found themselves with millions of foreclosures after more than a decade of high-risk lending.
Demand for homes had increased rapidly in the frothy market as loans became more accessible to consumers, many of whom could not afford to pay them. Prices soared and a bubble was created. When homeowners began defaulting on their mortgages in large numbers, the housing market bubble burst and lenders found themselves in significant financial …….
Source: https://www.businessinsider.com/personal-finance/frothy-market
