Saturday, April 20, 2024

Are we in a stock market bubble? | Graphics that matter

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One of the tricky things about asset bubbles is that they cannot be conclusively identified while they still exist. It wasn’t until a bubble burst that we can be sure it was still there. However, there are two necessary, if not sufficient, conditions for a bubble to exist. The first is an accelerated rise in prices that is forcing valuations near historic highs. The second is increasingly speculative and senseless behavior by investors.

On the US stock market, this first box is clearly checked. Here is the Nasdaq index, strongly oriented towards technology, the sector where valuations have been the most foamy. It has increased by 40% this year despite the small problem of a global pandemic and an accompanying weak economy.

Crazy behavior? There are also many. Perhaps the most successful example of investor madness is a barely profitable electric car company that has seen its share price eightfold this year. Here is a chart of Tesla stocks. A few weeks ago there was a two-day period in which Tesla added twice the total market value of the Ford Motor Company. Or how about the spike in the price of an asset that depending on who you talk to may have no underlying value? Bitcoin cryptocurrency.

Now the argument that there is no bubble in the US stock market is that stocks must be so expensive because government bond yields are so low. That is, if stock prices are high, the premium investors receive for owning stocks over bonds is actually at the low end of the historical range.

Here is a graph of the 10-year adjusted or actual inflation return. Big investor Jeremy Grantham claims that justifying high stock prices with reference to historically low bond yields is nothing more than justifying one asset bubble by reference to another. He might be right. But the fact remains that the Federal Reserve can keep bond yields low simply by buying more and more Treasuries – that is, unless inflation spikes and things get out of hand. from the Fed.

The question of whether we have an asset bubble in the US stock market is no more and no less than the question of whether we have been too complacent about the possibility of inflation. If you own stocks, watch the prices of everything else closely.


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