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News

The Bubble Question

Evan Cooper Sep 29, 2015


These days, nothing is like it used to be — not even so-called stock market bubbles. The most recent “classical” bubble was the dot-com mania at the turn of the century. (OMG, “turn of the century” sounds like a phrase used by people who remember the St. Louis World’s Fair of 1904.)

To me, the marks of a classic bubble are a general optimism about the stock market combined with little sense that things are weird or crazily overpriced. All that changes, of course, after some triggering event splashes cold water on the faces of investors and makes them realize that prices are crazy. Then, amid the gloom, everyone blames everyone else for their losses and says they knew it was a bubble all along.


A Classic Bubble


The dot-com boom was a classic because until it really went wild, few thought the exuberance was a bubble. Everyone “knew” that the Internet was the future and there was mass excitement about tech companies revolutionizing the economy; it was simply logical to buy tech stocks. IPOs that created instant fortunes for the founders of any company with “Tech” or “Net” in its name were commonplace. Valuations based on nothing more than speculation seemed utterly sensible. How foolish and old-fashioned it was to question the hot stocks on the NASDAQ when all they did was keep going up.

Until they didn’t.


Today’s Situation


Cut to 2015. Today, after the violent updrafts and downdrafts of August and September, the market is back down to where it was last October. The idea that we’re in a bubble seems odd. After all, if we are in a bubble, wouldn’t the recent declines mean that whatever bubble existed has collapsed? And if we are or have been in a bubble, where’s the exuberance? True, over the last couple of years the market recovered from its 2008 collapse, but nobody was doing the modern version of the Charleston or talking about stock tips.

But maybe we’re in a new kind of bubble — one where prices are irrationally high, yet nobody is very enthusiastic.


Shiller’s View


Respected Yale economist Robert Shiller, who is also the brains behind the S&P/Case-Shiller Home Price Indexes, recently said that despite recent downdrafts the market is in a bubble and that the Dow Industrials could fall to 11,000 — about a 30% decline from its current level.

“It looks to me a bit like a bubble again with essentially a tripling of stock prices since 2009 in just six years and at the same time people losing confidence in the valuation of the market,” Shiller recently told the Financial Times.

He added that based on his analysis, investors’ fears of the market being overvalued is now greater than it has been since 2000.


Yes or No?


So are we or are aren’t we in a bubble? Maybe it’s a matter of semantics. The lack of exuberance would seem to indicate that we’re not. But the market could very well be overvalued because of a misreading of the future. If we are heading into recession, and if all the efforts of the world’s central banks can’t keep deflation at bay, there’s a good chance that stock markets are overvalued because they are overestimating future earnings.

If that’s the case, when investors come to the realization that stock prices are out of alignment with future earnings, we could see a market decline. Call it the bursting of the bubble or just a rational adjustment to the new reality. Whatever you call it, it’ll still be painful.


Image courtesy of oana roxana birtea at FreeDigitalPhotos.net

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