Pricking the Stock Market Bubble Debate
We recently posted a note about the definition of a “bubble.” We thought it would be worth our while to share the thoughts of billionaire Ken Fisher’s firm on this issue. We share this, not as a firm prediction, but an analysis by an individual who’s more often right than wrong.
Are stocks about to froth over? With many indexes routinely clocking new highs, bubble chatter is easy to come by. One former presidential budget advisor says stocks are in a bubble! Our soon-to-be Fed head and one of her predecessors say no such bubble exists! A popular newspaper weighed in, too, corralling a few “experts” to opine on the issue. All the hoopla suggests there is a bubble … in bubble talk! In stocks, however, evidence suggests otherwise—this bull has plenty of fundamental support and rational reasons to keep on running.
What tends to move stocks most is the gap between economic and business fundamentals and the degree to which these fundamentals are appreciated. A stock market bubble forms when expectations about publicly traded companies’ future earnings exceed reality—when expectations become inflated. In the late 1990s, for example, Tech stocks with little revenue, unproven track record of success and poor business models shot sky high. Euphoric sentiment was defying fundamentals—glee, driven largely by past returns, was the only thing holding them up. Fundamentals eventually won the day, and sentiment followed after investors gradually saw their irrational bets go south. The bubble burst.
But today’s market looks nothing like that. Expectations are pretty low—few fathom that profits can keep growing and the global economy stay firm or even reaccelerate. Signs of optimism are guarded at best, and are often loaded with “yeah buts.” And keep in mind, bubbles don’t form overnight and are very difficult to detect. So difficult, in fact, that if everyone’s talking about them, they probably aren’t there. Constant bubble talk is self-deflating—it fosters fear and skepticism.
So why do some argue that we are in a bubble? Perhaps it’s because of the recent spate of social media IPOs, which may scare folks into thinking that markets are partying like it’s 1999—just before the Tech bubble burst. However, there are many differences between now and then. Sure, there may be some euphoria in social media, but social media is a small subset of IPOs. Consider: In 1999, there were 368 IPOs in tech alone. In 2013, Twitter made 33. Even if you think Social Media firms are frothy, they’re a tiny portion of the overall market and don’t necessarily reflect broader sentiment. Among tech companies, recent IPOs are trading at 5.6 times sales, compared with 26.5 times sales in 1999—investors aren’t placing exuberant valuations on yet-to-be-seen sales. And most of today’s IPOs aren’t Tech—they span most sectors, and many are higher-quality companies with real business plans compared to the flash-in-the-pan tech companies from the ‘90s. Hilton, an IPO scheduled to launch soon, has a rather time-tested business model, if nothing else.
Others believe stocks are propped up by something artificial (ahem, quantitative easing) and once it’s removed, the market will crash. The case: The Fed’s QE program has pushed investors from Treasurys to equities, in search for better return, and this is why the stock market has done well. Once interest rates rise, investors will drift back to fixed income, and stocks will fall. Yet data don’t support the notion of some massive rotation from bonds to stocks since QE began. Nor would that even be necessary for stocks to rise—there is a seller for every buyer. Stocks are an auction market—buyers’ willingness to pay higher prices is what matters, not the sheer number of buyers.
Philosophically, too, the notion fixed-income investors would chase higher yields in stocks is flawed. Perhaps some might, but many investors own bonds to reduce expected short-term volatility, particularly if they have higher cash flows. If they were dissatisfied with Treasury yields, they probably wouldn’t rush headlong into stocks, a more volatile asset class. They’d likely move to another form of fixed income (e.g., corporate bonds).
Finally, some suggest hot stock markets are detached from slow economic growth. True, this expansion is one of the slowest in modern history, but stocks aren’t the economy. Stocks are shares of publicly traded companies and reflect the private sector. While headline GDP growth hasn’t been stellar, much of the detraction has come from state, local and Federal government spending reductions. Business investment is closing in on all-time highs, profits are at all-time highs and rising, and S&P 500 earnings and revenues continue growing. Heck, earnings hit their first all-time high two years ago! Stocks hit theirs earlier this year. Stripping this influence out shows a stronger private sector—and the gap between how folks perceive the economy (pervasive claims of a sluggish, flat, fake or only “technical” recovery) is a great illustration of the dearth of euphoric sentiment. With this in mind, it seems tough to argue stocks are wildly higher than reality warrants. It seems more like the reverse.