Friday, November 8, 2013

We Are in a Stock Market Bubble; We Are NOT in a Stock Market Bubble. You Decide.

The US markets are up again today and the VIX is down, adding to a remarkable year of positive stock returns and reduced implied risk. The Indices snapshot is included below.

Provided by Livevol

The question I'd like to address in this note is whether or not we are in a stock market "bubble."  Of course, you know before even reading the rest of this post that I don't know.  But, I'm going to provide some pretty strong arguments that we are and that we are not.

Let's start simply with facts.  I have included the annual charts for the NASDAQ and S&P 500, below.

Provided by Livevol

We can see greater than a 35% return in NASDAQ and nearly 30% in the S&P 500.  So, bubble or not, the market is up huge this year. I have included the annual returns for the S&P 500 index since 1980, below.


I have marked in green 1995 and 1997, the only two years in the last 33 years that have seen higher returns in the S&P, although this year very well may surpass both of those years when all is said and done. I also note that for both of those years (1995 and 1997), the market was up huge again the following here.

Finally, I have included a two-year return chart of the VIX spot, below.

Provided by Livevol

We can see that the VIX (the "fear index") is down ~65% over the last two-years.  So, either complacency has set in, or, we are literally in a less volatile (less risk) period.

OK, those are the facts, let's get into bubble arguments (pro and con).

Argument: We are in a bubble
Below I have included several snippets from articles that point to a conclusion that the market in general and the technology sector in even greater specificity is in a bubble.


Source: via Yahoo! Finance; Fed-Induced Equity Bubbles Appear Ready to Pop, written by By Richard Suttmeier.

NEW YORK (TheStreet) -- [] The Dow Industrial Average set a new all-time high at 15,797.68 yesterday, which followed a new all-time high for the Dow transportation average set at 7131.80 on Monday. The latest all-time high for the S&P 500 was set at 1775.22 on Oct. 30 with the Russell 2000 matching that feat on the same day with an all-time high at 1123.26. The Nasdaq set its latest multi-year high at 3966.71 also on Oct. 30.

[] [T]he ValuEngine valuation warning reached its severest 2013 levels on Nov. 6 when 83.3% of all stocks were overvalued, with 53.3% overvalued by 20% or more. This was partially caused by the rise in the yield of the 30-year Treasury bond to 3.75%.

[] Note that 15 of 16 sectors were overvalued by double-digit percentages. We showed that 12 sectors were overvalued by 21.6% to 28.1%. The year to date gains are indeed impressive as are the gains over the last 12 months, but note that the P/E ratios are extremely elevated between 17.12 and 30.66.

After monthly benchmark revisions to ValuEngine data two interesting changes have occurred this morning. All 16 sectors are now overvalued as the basic materials sector shifted to 6.65% overvalued from 3.67% undervalued. The most overvalued sector is now multi-sector conglomerates at 31.07% overvalued vs. 25.47% on Nov. 6.

The title of the article certainly summarizes the position argued.  Certainly it is a fact that the S&P 500 and Dow Jones Industrial Average are at all-time highs. No argument there.

Key phrases from above:
"83.3% of all stocks were overvalued."
"All 16 sectors are now overvalued."

But, there's more... a lot more...

Source: Business Insider via Yahoo! Finance; Here's The Evidence That The Tech Sector Is In A Massive Bubble, written by Jim Edwards.

Here's the evidence that we're in a new tech bubble, heading for a crash, just like the dot com bust of 1999.

Fred / Think Progress

Before we get into specific evidence that the tech sector is inflated, it's worth restating the macro-economic context: Interest rates are basically at zero and have been for some time. When borrowers are paying close to zero interest on loans, that makes money cheap to get. This chart shows the Fed's target rate for interest since 1970.

The stock market is at a peak, which is exactly what you'd expect in a zero-interest environment.

Yahoo Finance / Jim Edwards

We've had five years of solid growth in stocks. People who have invested in stocks in the last five years now feel very, very rich. What could possibly go wrong?


High stock prices and corporate giants who are rich with cash and need to invest it, PwC says. It's not just tech asset prices that are high. Salaries are high, too.
While unemployment generally may be high, in the tech sector it is very low.

Tech companies, led by Mark Zuckerberg at Facebook, are lobbying Congress to relax immigration rules so they can hire more foreign talent because they believe domestic talent has gotten too scarce and too expensive. It's driving up wages bills like crazy. Matt Allen, a tech recruiter at Vertical Move, told me recently:

We're experiencing first hand greater insanity than the dot-com days when Interwoven Software was pulling out BMW Z3's for engineers who joined. Instead, we're seeing sign-on bonuses for individuals five-years out of school in the $60,000 range. Candidates queuing-up six, eight or more offers and haggling over a few thousand-dollar differences among the offers. Engineers accepting offers and then fifteen minutes before they're supposed to start on a Monday, emailing (not calling) to explain they found something better elsewhere.

[See article for several specific examples]

Timothy Draper is the founder of Draper Fisher Jurvetson, a venture capital outfit that has invested in dozens of tech startups. He's been around since the days when Hotmail was the big new thing. He recently told The New Yorker that he believed tech venture capital may have reached the top of its cycle:

“I’ll draw you the cycle,” he said, taking my notepad and pen. He scrawled a large zigzag across the page. “This is a weird shark’s tooth that I kind of came up with. We’ll call it the Emotional Market of Venture Capital, or the Draper Wave.” He labeled all the valleys of the zigzag with the approximate years of low markets and recessions: 1957, 1968, 1974, 1983, and on. The lower teeth he labeled alternately “PE,” for private equity, and “VC,” for venture capital. Draper’s theory is that venture booms always follow private-equity crashes. “After a recession, people lose their jobs, and start thinking, Well, I can do better than they did. Why don’t I start a company? So then they start companies, and interesting things start happening, and then there’s a boom.” Eventually, though, venture capitalists get “sloppy”—they assume that anything they touch will turn to gold—and the venture market crashes. Then private-equity people streamline the system, and the cycle starts again. Right now, Draper suggested, we’re on a venture-market upswing. He circled the last zigzag on his diagram: the line rose and then abruptly ended.

"Abruptly ended"?

Let's hope he's wrong.

OK. That article when read fully (not just the snippets does give several examples that draw scary similarities to 1999 and the "Internet Bubble.")

Key Phrase
"Here's the evidence that we're in a new tech bubble, heading for a crash, just like the dot com bust of 1999."

But, believe it or jot, there are arguments, strong ones, that we are not in a bubble, but rather an economic boom.

Argument: We are NOT in a bubble

1. Home prices bottomed out in 2012 and have been rising by double-digits, year over year.

2. Existing home sales — which account for more than 90% of the housing market — are up double digits from last year even after Sep numbers:

"Home sales cooled in September because of higher interest rates, and the recent government shutdown may put a damper on activity for this month, too.

Existing home sales dropped 1.9% in September to a seasonally adjusted annual rate of 5.29 million from 5.39 million in August but were still up 10.7% from last year, the National Association of Realtors said Monday.

The decline was expected, given higher rates and rising home prices that pushed affordability to five-year lows, says Lawrence Yun, NAR chief economist."

Source: USA Today September existing home sales fall 1.9%

Ophir's Note: New Home Sales are starting to paint a different picture.

3. Unemployment is dropping.

United States Dept. of Labor

Here is the data in numbers, rather than a chart (same source):

United States Dept. of Labor

While there are good arguments made about (1) the "real unemployment rate" (adjusted for discouraged workers that leave the work force) is much higher and (2) the "quality" of jobs being created are poor and do not provide livable wages, the bottom line is, massive amounts have jobs have been created (of whatever kind).

Bigger point: There is room for this economy to grow since the long-term trend is closer to 5.5% unemployment.  That would mean we are not in a bubble (a peak), but actually in the midst of a continuing recovery.

OK.  That's it.

Now you decide.  Are we in a bubble or not?

My opinion... bubble -- no, overheated stock prices, yes, but they aren't ready to pop.  Not yet.  But what the hell do I know...seriously, what do I know?...

This is trade analysis, not a recommendation.

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