As last year’s robust gains continued into the fourth quarter, financial analysts were using an explanatory term you might be more likely to hear from a shaman: animal spirits.1

They were using it to refer to the strong emotions that sometimes drive economic behavior, especially the herd mentality that seems to take over during periods of market volatility. The term was first used in this sense by British economist John Maynard Keynes in his foundational 1936 publication The General Theory of Employment, Interest, and Money.2

Carla Tardi writes for Investopedia, “Animal spirits represent the emotions of confidence, hope, fear, and pessimism, that can affect financial decision-making.” When spirits are low, they can hold back the market, when by all other measures it should be experiencing growth. Conversely, when spirits are high, they can fuel speculation in investments that have no discernable reason for growth.

A classic example of animal spirits in action is the dotcom bubble at the turn of the 21st century. With the internet seeming to offer unlimited possibilities, simply tacking “dotcom” onto the name of a company would dramatically increase its market value. The realization of this folly came in the form of a dramatic correction, especially in the new technology sector. The tech-heavy NASDAQ, which had seen a fivefold gain from 1995-2000, lost more than three quarters of its value over a six month period.3

Recently, we’ve seen what looks like so-called animal spirits in action when in early August the S&P 500 experienced a single day drop of nearly 3% on bad news from Japan. At that point, we were being bombarded with headlines predicting that decline was “just the beginning.” And, again, in November when the market spiked more than 2.5% the day after the presidential election. In neither case did the underlying fundamentals warrant such a significant and rapid reallocation of capital. But that’s how the broader market processes all the available information, including folks who may be panicking for no rational reason.

While noting the many references to animal spirits in recent financial headlines, investment writer Ben Carlson is hopeful that not everyone shares this irrational exuberance. “Once everybody is in the pool, I get a little nervous.” He says that he much prefers a bull market that climbs a “wall of worry.”

One might make the case that last year’s climb of more than 24% was up such a wall. Consumers were not happy with the economy nor particularly confident about their financial future.4 The biggest evidence of this was the election, which saw a switch of parties with the economy being a major factor.

Since volatility is a key contributing factor to the strong emotions which lead to irrational behavior, and 2025 is sure to have its share of tumultuous events, perhaps the one thing investors are guaranteed are periods where animal spirits will send the market up or down in the short-term.

Regardless of what kind of sentiment is driving the market over the short-term, the prudent investor will work with his or her trusted advisor to ensure their portfolio is designed for their specific circumstances and appropriate in a bear or bull market, rebalancing as necessary.