Another bull market, another round of warnings about central banks blowing bubbles.
Since March, U.S. stocks have rallied about 40% from their pandemic-panic lows and now reside near the same level as in December 2019, when the U.S. economy was 10% larger, 15 million more Americans were employed and corporate profits were at least 30% higher.
Yawning as it is, however, the gap between stock prices and economic conditions is not unprecedented. As the Great Depression was taking hold in late 1929, stocks rallied by a similar amount over the ensuing five months.
It is understandable that skeptics see the current equity market as floating on thin air. The disconnect between stocks and consumer confidence — two metrics that usually track closely — is massive. By historical standards, though, today’s see-no-evil stock market is not in bubble land.
Traditionally, asset-price bubbles are characterized by extreme optimism about the economy, overwhelmingly bullish sentiment among retail investors, broadly inflated valuations, giddy talk of a “New Economic Paradigm” and a rush of initial issues coming to market.
Few if any of those factors are in clear evidence today.
While the rampant speculations of homebound amateurs wagering their stimulus checks on the commission-free Robinhood trading app have been well chronicled, it is doubtful that small investors have the financial firepower to move most stocks higher by themselves.
Valuations, while at a multi-decade high, tell a similarly not-quite-bubbly story. At about 22 times next year’s forecasted earnings, the S&P 500 is expensive by historical standards, but not as exorbitantly overpriced as near the end of the info-tech bubble in the late 1990s.
In fact, much of what now could be viewed as irrational exuberance (aside from those small investor speculations) appears mostly confined to a group of large technology companies that seem well-positioned to benefit from the pandemic. Even there, however, valuations are nowhere near those of two decades earlier.
Fear of Missing Out
But if it’s not quite a bubble, what is it? Perhaps the best description is what’s been called a FOMO market — a Fear of Missing Out on gains in an investment world devoid of alternatives.
More than half of the world’s fixed-income securities trade with a yield of under 1%. Most inflation-adjusted yields are negative. Those skimpy returns have pushed investors into riskier assets like stocks, boosting prices with little regard to the underlying economy.
Still, there are reasons to be cautious, if not wary.
Though it couldn’t necessarily be characterized as complacency, there nonetheless seems to be an emerging consensus that the Federal Reserve can backstop financial markets virtually at will. That assumes, however, that central bank loans can indefinitely forestall corporate bankruptcies. In coming months, that optimistic assumption could be called into question.
Also, the spike in COVID-19 cases in Florida, Texas and California has taken a renewed toll on consumer confidence, which after rebounding in June, has fallen back to pandemic-level lows. It is difficult to imagine the U.S. economy returning to normalcy until the consumer segment — which accounts for about 70% of economic activity — feels safe in going about their normal lives.
Finally, there is the possibility of a grave constitutional crisis arising from the presidential election, now less than 100 days away.
President Donald Trump has refused to say if he will accept the result if defeated, and financial markets will not react with indifference to such a scenario, which could take weeks or months to play out. More than anything, investors loathe uncertainty, and a president refusing to leave office certainly qualifies as uncertainty.
Longer term, the most important question might be whether monetary policymakers can extricate themselves from supporting asset prices without causing economic and market distress. On numerous occasions since the global financial crisis in 2008, such attempts were met with selloffs in both the equity and fixed-income markets. Addictions are hard to kick.
It is worth noting that the five-month rally that followed the 1929 stock market crash ended in tears. From April 1930 through mid-1932, prices declined by over 80%. But that was before the Fed had license to print money and before a social safety net was created in the 1930s.
So far, those changes have saved the day. We’ll have to see about tomorrow.
Tom Saler is an author and freelance journalist in Madison. He can be reached at tomsaler.com
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