Are Stocks in a Bubble….Again?

The S&P500 ended the week almost unchanged (up just a fraction of one percent). Volume was very light, which as usual means that any buying was not enthusiastic. And volatility was almost unchanged—it’s still firmly stuck at an ultra-complacent level.

Technically, the S&P500 remains extremely overbought on the weekly charts. And while it’s not as extreme, the S&P on the daily charts is also very overbought. On both resolutions, the S&P is hugging the upper Bollinger bands and stretching far away from the respective 200 day moving averages.

Nothing, it seems, is able to shake the steady march higher. Both good news and bad news appear to push the equity markets one way only—higher.

Speaking of bad news, the US economy continues to limp along. Last week, the pending home sales index fell badly. The Dallas Fed survey disappointed. Retail sales missed. Consumer confidence suffered its largest drop in two years. Initial jobless claims were higher than expected. PMI Manufacturing dropped. Consumer and producer prices were subdued….certainly not what one would expect in an economy that’s growing robustly. Only ISM manufacturing beat expectations.

By almost every measure, the US stock market is not only over-priced, but it’s now arguably entering bubble territory.  And what’s shocking is that this is happening only four and a half years after collapsing by almost 60%.

What are some of the signs of this bubble?

The Shiller P/E is now above 25, the second highest level since 1929. The stock market’s valuation vs US GDP is now over 50% above the long-term average. As noted above, the market rises on all news—both good and bad news seem to push prices higher. Yet at the same time, corporate sales are stagnating and earnings growth is faltering. This means that  almost all of the market rise over the last 1-2 years has come from an expanding P/E multiple, not robustly growing earnings.

What’s the biggest argument against any type of bubble?

Simple. Given that corporate earnings have ballooned to record levels relative to US GDP, you must assume that these record high earnings will continue…….permanently.  How stretched are these earnings? They’re about 70% above where they usually are vs. GDP, primarily due to massive deficit spending by the government and by the inability to save among US households.

So if you buy into the “stock market is still cheap” argument, you’re implicitly buying into the premise that the sky-high level of corporate earnings will never revert back to 100 year norms. Ever.

If so, good luck with that.

The prudent investor, who always maintains a long-term investment horizon, would vehemently disagree with this premise. And he’s sufficiently patient to wait for better buying opportunities.

Better buying opportunities will come. They always have in the past. And it will be no different in the future.

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