Robert Samuelson
WASHINGTON – The question about the stock market is whether the bull is a bubble. The 1990s’ “tech bubble” and the recent “housing bubble” have conditioned us to think that almost any sign of investor craziness is going to end badly – and the stock market seems a bit crazy. At the end of November, reports Wilshire Associates, stocks were up 28 percent for the year, representing a gain of about $4.8 trillion. From the market’s most recent bottom on March 9, 2009, when the economy was in a tailspin, the increase has been 180 percent, or nearly $15 trillion. If you dislike this comparison, then measure the gain since the market’s pre-recession high on Oct. 9, 2007. The increase is 21.5 percent, or $4.2 trillion.
What’s more, there’s a widespread expectation that stocks, despite temporary setbacks, will continue to advance. After all, the Federal Reserve is pumping $85 billion a month into financial markets – about $1 trillion a year – by buying bonds. Much of that money (the theory goes) props up stock prices.
The impending change in leadership from Ben Bernanke to Janet Yellen as Fed chairman is viewed positively. Yellen will wait longer, it’s said, to reduce the Fed’s pump-priming. As a Wall Street Journal headline put it: “‘Dovish’ Yellen Keeps Gloom at Bay: Incoming Fed Chairwoman’s Message Has Given Comfort to Investors and Fueled Stocks’ Resilience.”
Still, all the happy talk will be just that if the market’s surge turns out to be a bubble, which – once burst – wrecks confidence and, perhaps, converts the plodding recovery into a new recession. So, is today’s market a benign boom or a bad bubble?
Here are three crucial facts.
First, investor sentiment has clearly shifted toward optimism. One survey of financial newsletters finds that 57.1 percent are “bulls” (expecting higher stocks) and only 14.4 percent are “bears” (expecting lower stocks). The ratio of almost 4-to-1 is the highest since March 1987, says economist Edward Yardeni of Yardeni Research.
Among his clients – pension funds and other large investors – “there’s less anxiety and more willingness to see the upside,” he says. “When we didn’t go over the fiscal cliff [the cancellation of all the Bush tax cuts] at the beginning of the year, there was a huge sigh of relief. People had anxiety fatigue. … No one talks anymore about the disintegration of the eurozone.”
Of course, the optimism could cut either way. It may indicate that sober analysts agree that stocks are a good buy. Or it could signal that greed and crowd psychology have taken charge.
Second, the market’s gains are not unusual. Following deep declines, stock rebounds are often large. Since 1932, there have been 13 bull markets, defined as gains of more than 20 percent, according to Standard & Poor’s. For all bull markets, stocks have risen an average of 165 percent based on the S&P index of 500 stocks. Stocks’ present increase through November is 167 percent (the S&P index differs slightly from the Wilshire index cited earlier). By itself, this year’s gain doesn’t suggest an overvalued market.
Finally, growing profits explain much of the market’s increase. In theory, stock prices reflect present and future profits, and – despite a sluggish economy – corporate profits have increased impressively. By government figures, they’re up 39 percent from their 2006 pre-recession peak. Profit margins are near record levels, about 9.6 percent of corporate revenues, notes S&P’s Howard Silverblatt. Higher profits have kept a key stock market indicator – the price-earnings ratio (P/E) – well within historical norms, finds a study by the McKinsey Global Institute, the consulting company’s research arm.
What’s unclear is how much the Fed’s bond-buying, called “quantitative easing” (QE), has boosted stocks. Zilch, says economist Susan Lund, co-author of the McKinsey study. “There’s a short-term effect, but then the market reverts to long-term trends,” she says.
Improved profitability explains stocks’ rise. If true, cutbacks in QE won’t much affect stocks. Silverblatt is less sure. “Definitely the Fed helps,” he says. “There’s more buying, but quantifying it [the benefit] is difficult.”
What’s clearer is that stocks and the “real economy” of jobs and production have become disconnected – and that this cannot continue indefinitely. There are practical limits to how much companies can improve profits without stronger economic growth and higher sales. If these don’t materialize, we may discover that the market is not a bubble but a blob that goes nowhere quickly.
Robert Samuelson’s column is distributed by The Washington Post Writers Group.