Talking About Market Bubbles

When will this market bubble finally burst? The question is asked a lot lately.

Market indexes set a lot of records during the last couple of years, with the latest being the Dow Jones Industrial Average closing above 22,000. Some analysts believe the entire market is in a bubble, while others say that only stocks, such as technology companies, which outpaced the indexes, are in a bubble.

We experienced a stock market bubble in the late 1990s, which was based primarily in tech stocks. There also was the residential real estate bubble in the 2000s. After those two experiences, many people now are on the lookout for more market bubbles.

The first contrast between those two bubbles and the current situation is that few people were calling them bubbles before they burst. The few that did cry “bubble” were early. They lost a lot of money (or missed out on profits) and endured a lot of ridicule before finally being proven right. Today seems very different. Many people are devoting a lot of resources to explaining why we’re in a bubble or at least very overvalued. It seems to be the consensus view.

Another contrast is what I’ll call the metrics. The fundamentals generally support current stock prices. Sure, there are select companies with very overvalued stocks. These generally are the hot young companies identified as “unicorns” in the media. On the whole, the indexes are at high valuations, but they’ve been at even higher valuations in the past.

Also, interest rates, economic growth and earnings growth all remain favorable. So, valuations could stay at these levels for a while and even rise.

The early stages of the bull market were supported primarily by Federal Reserve policies. The last couple of years, however, we’ve seen steady, sustainable growth in the economy and earnings.

Most importantly, we don’t have the traditional signs of excess associated with a bubble that’s about to burst. I don’t hear stories of people taking out home equity loans to buy stocks or quitting their jobs to become day traders.

I believe there are better opportunities in Latin American and European stocks than in U.S. equities. And the bull market in U.S. stocks will end at some point. But the usual early indicators of a recession or bear market aren’t flashing red, and I don’t see behavior typical of a bubble (except in crypto-currencies, such as bitcoin).

As always, I recommend having diversification and a margin of safety in your portfolio. My recommended portfolios have relatively low allocations to U.S. stocks because I believe there are better opportunities in other markets. But I’m not recommending investors put all their money in cash or sell short U.S. stocks.

The Data

Small business owners are feeling better, according to the NFIB Small Business Optimism Index. The index rose most of 2016 and surged after the election before declining after January. This month it increased to 105.2 from 103.6 last month. That puts it just below the 12-year high set in January. The business owners reported stronger consumer demand.

The Consumer Credit report also supports the idea that households are increasing spending. Credit card use has been rising in recent months, and that’s a sign of higher household spending. Revolving credit increased $4.1 billion in June after a $6.9 billion increase in May. The overall Consumer Credit increase was below expectations because of a decline in auto loans.

Productivity had a big increase in the second quarter. Productivity’s been lagging the long-term average for a few years. In the second quarter, productivity increased by 0.9%, compared to 0.1% for the first quarter and declines for the first two quarters of 2016. Even after second-quarter 2017’s big increase, the 12-month rise is only 1.2%.

In the same report, unit labor costs increased by only 0.6% in second-quarter 2017, compared to expectations of a 1.1% jump. It marks a big slowdown in labor costs from a first-quarter increase of 5.4%, after a sharp upward revision.

Inflation, as measured by the Producer Price Index, remains very tame. The headline PPI was down 0.1%. After excluding food and energy, it still was down 0.1%. For 12 months, the PPI is 1.9% for the broad index and 1.8% after excluding food and energy.

As we expected, last week’s Employment Situation reports were strong. New jobs created were substantially more than the consensus at 209,000, and last month’s number was revised even higher to register 231,000 new jobs. Even better, average hourly earnings increased 0.3% for a 2.5% 12-month increase. These numbers all indicate recent economic growth is sustainable.

The JOLTS (Job Openings and Labor Turnover Survey) also revealed a strong labor market. Job openings increased sharply again. The number of hirings was significantly less than the job openings. Also, the number of workers voluntarily leaving jobs increased a bit. Those two factors indicate employers are likely to have to raise wages to attract and retain workers.

New unemployment claims increased 3,000. That keeps the weekly and four-week numbers near historic lows.

The Markets

The S&P 500 declined 0.10% for the week ended with Wednesday’s close. The Dow Jones Industrial Average continued rising to gain another 0.26%. The Russell 2000, on the other hand, declined 1.10%. The All-Country World Index lost 0.36%. Emerging market equities decreased 0.09%.

Long-term treasuries rose 0.47%. Investment-grade bonds fell 0.46%. Treasury Inflation-Protected Securities (TIPS) returned 0.56%. High-yield bonds declined 0.60%.

The dollar reversed course, gaining 0.80%.

Energy-based commodities rose again, adding 0.07%. Broader-based commodities returned 0.68%. Gold gained 0.08%.

Bob’s News & Updates

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