Bubble predictions are headline-grabbing claims attract reader/viewership and push more than a few worried individuals to act but, like all forecasts, these bubble warnings should be taken with a grain of salt. [Here’s why.]
So says Eric D. Nelson, CFA (servowealth.com) in edited excerpts from his original article* entitled Talk of a Stock Market Bubble is Baloney.
[The following is presented by Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com and www.munKNEE.com and the FREE Market Intelligence Report newsletter (sample here – register here). The excerpts may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.]
Nelson goes on to say in further edited excerpts:
In case you haven’t noticed, there has been a surge in market forecasts lately claiming that the recent run up in prices has resulted in a stock “bubble”. There is no universal definition of what actually constitutes a bubble, so we’ll settle for the vague description of “a condition where market participants drive stock prices well above their value in relation to some system of stock valuation.” The fear of a bubble, of course, is that when the euphoria ends, prices will fall to more pedestrian levels resulting in a significant loss for existing investors who don’t bail out first.
Pundits have all sorts of valuation metrics they use to compare stock prices to historical trends—from simple one-year price/earnings multiples to “smoothed” ten-year earnings averages relative to price. But none of them provide much accuracy in terms of signaling the precise time to enter and exit the market. The best we can say about them is when valuations are relatively high, future returns may be a bit lower than average and vice versa.
Probably the best method of “bubble detection”, to the extent such a thing is even possible, is to simply observe an investment’s recent past performance history to measure how far in excess of the long-term average it has been. For example:
- Gold experienced a ten-year run starting in 1971 where it returned almost 32% per year.
- US small cap stocks earned 27% per year for the decade ending in 1984.
- Japanese stocks produced over 28% per year returns in the 1980s.
All of these results were well above long-term expectations and unsustainable, as each market eventually “reverted to the mean.” Have we reached this point again?
Table 1 below looks at three different investment portfolios: a traditional US total stock index, followed by two more diversified asset class mixes—an all-stock allocation (“Equity”) and a balanced stock and bond combination (“Balanced”).
For the recent ten-year period, investment returns have been healthy despite the debilitating setback in 2008. The US Total Stock Index earned almost 8% per year. This is far from an alarming rise in prices, as the average over the previous 75 years was 1.7% higher, at +9.6% per year. So far, so good. If lower-than-average returns have created a market bubble, that would certainly be the first time.
How about for more diversified asset class portfolios? They’ve certainly done better than a simple total stock index, but this has always been the case.
In the recent period, the “Equity Asset Class Mix” earned a +10.3% annual return and the “Balanced Asset Class Mix” earned +8.7% per year but these results were both 1.6% per year lower than their long-term historical average using US-only indexes due to availability. What hasn’t changed in either period is the spread of outperformance for the asset class mixes relative to the total stock index—about +2.4% in each period for the equity version, and +0.8% in each period for the balanced version. Of the two, arguably the more impressive result is the balanced mix. Despite its lower level of outperformance, it achieved this feat with about 40% less risk than the US Total Stock Index in each period.
Warren Buffet once said something to the effect that forecasts say more about the person making them than the actual claim itself, and that certainly holds true for bubble predictions. These are headline-grabbing claims that are sure to attract reader/viewership and more than a few worried individuals who will be pushed to act but, like all forecasts, these bubble warnings should be taken with a grain of salt.
We have yet to develop a sure-fire method for predicting when the stock market will take a tumble and, even in cases where extreme and seemingly-excessive price increases do occur, they can continue for much longer than anyone would assume, rendering early action more costly than no action.
In just the last two decades, for example, we’ve seen Nobel Prize-winner Professor Robert Shiller predict both the tech stock and real estate bubbles. Unfortunately, his first warnings were about five years early in each case, and we watched both those markets appreciate another 100% (in the case of the S&P 500 and REIT index) prior to eventually falling. In neither case did subsequent declines come close to retesting the market levels seen when his prognostications were first made.
As for the current state of the global equity markets, things appear to be pretty normal. Recent returns (last 10 years) have been about what we’d expect and within a small margin of error around the longer-term historical perspective. More diversified asset class portfolios have produced a sizable advantage over traditional total stock indexes, or produced similar returns with significantly less risk, but this too is par for the course. So simply put—talk of a stock market bubble is baloney….
[Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.]
*http://servowealth.com/resources/articles/talk-stock-market-bubble-baloney (Copyright © Servō Wealth Management)
I would think that we are probably in the slow build-up to something interesting – a badly overpriced market and bubble conditions. My personal guess is that the U.S. market, especially the non-blue chips, will work its way higher, perhaps by 20% to 30% in the next year or, more likely, two years, with the rest of the world including emerging market equities covering even more ground in at least a partial catch-up. Read More »
[Given the] big swings in enthusiasm for owning common stocks [we thought it timely to present] our opinion on the current temperature of the U.S. stock markets as to what’s hot and what’s not and the reasons why that is the case. Read More »
The real value of the stock market is positively correlated, over time, with the amount of freight hauled by the nation’s trucks (in other words, the physical size of the economy has a lot to do with the real, inflation-adjusted value of the economy) and the latest numbers (see chart) strongly suggest that we are not in a stock market bubble. Read More »
There’s nothing to be bearish about regarding the stock market these days. I’ve reviewed my 9 point “Bear Market Checklist” of indicators and it is a perfect 0-for-9. Not even one indicator on the list is even close to flashing a warning sign so pop a pill and relax. There’s no immediate danger threatening stocks. Read More »
Right now there’s nothing to be bearish about. I say that with conviction, because my “Bear Market Checklist” is a perfect 0-for-9. Heck, not a single indicator on the list is even close to flashing a warning sign. We’ve got nothing but big whiffers! Take a look. Pop a pill and relax. There’s no immediate danger threatening stocks. Read More »
There are several fundamental reasons to believe that this week’s stock market activity, where the S&P 500 has moved more than 4% above the 13-year trading range defined by the 2000 and 2007 highs, could mark the beginning of a long-term bull market and the end of the range-bound trading that has lasted for 13 years. Read More »
Today, I’m dishing on the unbelievable rebound in residential real estate, pesky rumors about the dollar’s demise and a resurgent U.S. stock market. So let’s get to it. Read More »
Are stocks in a bubble? While leverage has returned to the stock market driving up stock prices and aggregate demand in the process, margin debt is still shy of its all-time high as a percentage of GDP, so there is certainly some headroom for further rises. A look at the following 5 charts illustrate that contention quite clearly. Read More »
“A sluggish economy, political gridlock, tepid earnings, the European debt crisis, high gasoline prices…” I can’t really argue with Barron’s depiction of the current market environment yet, against all these seemingly negative conditions, the stock market keeps surging higher. Can it possibly continue, though? Read More »
U.S. stocks are off to one of their best starts in years. Most indices are up 10% year to date, prompting many investors to ask: “Are we in another bubble?” The answer is no, at least when it comes to equities. Here are three reasons why:
The mainstream financial press would like us to believe that because the S&P 500 and Dow 30 are at or near their record highs that it must mean we’re nearing the end of the current bull market and, as such, now must be a terrible time to buy stocks. Let’s not jump to any conclusions, though. Instead, let’s do our own due diligence to find out. Hint: If you’ve been stuffing cash under the mattress since the last market crash, you might want to finally go deposit it in your brokerage account. Here’s why… Words: 420
While I remain cautious on stocks and the risk trade, the technical picture shows that the uptrend to be intact and the bulls should still be given the benefit of the doubt for now. At this point, any call for a correction is at best conjecture [as evidenced by the following 4 indicators]. Words: 399; Charts: 4
The Swimsuit Issue Indicator says that U.S. equity markets perform better in years when an American appears on the cover of Sports Illustrated’s annual issue as opposed to years when a non-American appears on the cover. [What is the nationality of this year’s cover model? Can we expect returns above the norm or will we see a year of underperformance for the S&P 500 this year? Read on.] Words: 323 ; Table: 1
As we all know, money printing always leads to inflation. It’s just a matter of figuring out which assets get inflated. This time around gold is not the only beneficiary, stocks are, too, and I’m convinced that the chart below holds the key to the end of the bull market. Words: 475; Charts: 1
Ever since the Dow broke the 14,000 mark and the S&P broke the 1,500 mark, even in the face of a shrinking GDP print, a lot of investors and commentators have been anxious. Some are proclaiming a rocket ride to the moon as bond money now rotates into stocks….[while] others are ringing the warning bell that this may be the beginning of the end, and a correction is likely coming. I find it a bit surprising, however, that no one is talking of the single largest driver for stocks in the past 4 years – massive monetary base expansion by the Fed. (This article does just that and concludes that the S&P 500 could well see a year end number of 1872 (+25%) and, realistically, another 28% increase in 2014 to 2387 which would represent a 60% increase from today’s level.) Words: 600; Charts: 3
For the month of January, U.S. stocks experienced the best month in more than two decades [and the Dow hit 14,009 on Feb. 1st for the first time since 2007]. Per the Stock Traders’ Almanac market indicator, the “January Barometer,” the performance of the S&P 500 Index in the first month of the year dictates where stock prices will head for the year. Let’s hope so…. [This article identifies f more solid reasons why equities should do well in 2013.] Words: 453
As Winston Churchill once said: “A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty” and in that vain I challenge all readers to fight off the negativity, see long-term opportunity in global equity markets and, most importantly, remain invested. Your future self may thank you. Words: 732; Charts: 6
Use a portion of your portfolio in the form of credit spreads to protect and drive income over the next nine months. It’s an extremely simple strategy to learn and arguably the most powerful strategy in the professional options traders’ tool belt Read More »