Why The Stock Market Is Not In A Bubble

The big news in the financial sector these days is, of course, the stock market.  With year to date returns already over 15% (and counting), many out there are jumping in and proclaiming that the stock market is in a bubble and proclaiming that the bubble will burst.

I’m not buying it.

Or selling it, I guess would be the right term 🙂

Many of those who think we’re in a bubble use some combination of the following arguments to state their case:

  • The big run in the stock market has taken all opportunity away
  • Unemployment is not falling fast enough
  • Corporate profits are leveling off
  • Europe and Japan are in a recession
  • Our mounting national debt

Here’s my take on each of these.

  • Opportunity is not fully priced in –  When the economy and the market tanked in 2008-09, many people left the market altogether.  While many have returned, there’s still a lot of money sitting on the sidelines.  Some of those jaded investors may never return to the market, but I still think there are many investors who would consider re-entering the market.  There is upside
  • Unemployment is fine – One of the things that’s separated this recession from many others is that unemployment did not fall at the end of the recession.  Many argue that’s a bad thing, but I argue that it’s a good thing.  Companies aren’t just hiring en masse, but only hiring when they need positions.  I’d feel comfortable saying that the jobs being created today are more likely to stay in the event of a slowdown.  I think the job market is building a much more solid foundation, so while there are less jobs, I think they’re a sign of long term stability.
  • Profits are only one piece of the puzzle – Many companies are making record profits, but the rate of profitability is slowing.  First, this is to be expected as many companies are returning to profitability after suffering losses, so the first jumps are always the strongest.  Second, and more important, is even if profit growth does slow, many companies are continuing to strengthen their balance sheet.  They’re adding more cash reserves.  They are paying off debt.  They’re investing in new technology.  These are all things that will provide profitability way down the line, something that investors will pay a premium for.
  • Europe and Japan are less important – The crisis in Europe probably isn’t done and we’ll here more bad news along the way, but it seems to me, that compared to 18-24 months ago, Europe has leveled off.  If investors believe that the worst is behind, they will not discount stocks whose companies are exposed to Europe.  If the economies of those countries start actually showing signs of recovery, investors will be rewarded further.  As far as Japan, they’ve been in such a rut that I’m not sure they factor in much either way.
  • The Fed has the debt covered for now – Eventually the debt will catch up to us, but for the time being, I think the debt is a non-factor.  The Fed is keeping interest rates down, and there are signs that the national deficits will actually start falling, meaning that we’ll be adding less to the debt than we have in years past.  I fully expect this to be something that hits us hard down the line, but for now, I believe the risk is minimal.

These are simply my thoughts (I’m no investment professional) and I’m hoping that this leads to continued upward momentum in the stock market as I’d like to see some additional gains in my 401(k) and personal portfolio.

How about you, what do you think about the stock market and its chances for continued success in the short and long term?

18 thoughts on “Why The Stock Market Is Not In A Bubble”

  1. Gonna respectfully disagree a bit. Don’t know if we are really in a “bubble”, but keeping interest rates artificially low has dire consequences. My thought is many are investing in the market not because of confidence but rather because they have no choice, CD’s, money market and treasuries are a joke and have been for some time. So folks are investing ..just looking for yield in many cases. My thought is this doesn’t end well. At some point in time Mr. Bernanke must stop printing money and let the markets set the rates. And the “madness begins” as folks are attracted by higher interest rates on CD’s and such. The effect on the Country’s debt could be devastating, just imagine rates going from the below 2% they are today versus the historic norm of 5-6%. A challenge to say the least.

    • This, exactly. When interest rates rise and the stock market DOESN’T crash and burn, I’ll stop holding my breath.

      Also, Obamacare is going to be an enormous burden for many companies that already provide health insurance because it requires all kinds of coverage that usually isn’t a part of most insurance plans to be covered, and it’s also going to make employers with a lot of young, healthy, but low paid workers feel a very significant pinch because of new limit on differences in premiums based on age.

    • If markets keep up their gains, and people start pulling money out when interest rates go up, they’ll end up having capital gains which they’ll pay taxes on. This should increase revenue which could offset some of the increased debt costs that the government would have. Also, because of the massive amount of debt and the positive creditworthiness that we still have, I believe that even with increased interest rates, the government can still keep thse costs low.

  2. I’m inclined to disagree. Stock prices have raced up well above fair value for most companies. So either one of two things need to happen. Stock prices need to decline back to fair value, or the fundamentals need to rise to meet the current value of the stock. I suspect that in the future some of both will happen, but I don’t know how. Maybe there will be a broad market correction, or maybe the market will just flatline for a while as the fundamentals improve. Maybe some of each.

    • One of the points I outlined was that I believe that the fundamentals are improving through increased balance sheet strength. Even if profits rise modestly, that companies continue to pay off debt, increase cash and other asset holdings, will serve to minimize risks that Wall Street often uses to mark down stocks as this will lead to a better ability to remain profitable down the road.

  3. Part of the reason, you take the time and effort to have a reasonable asset allocation is to weather the corrections, volatility etc. Investing is long term and I want growth long term as well. Short term there will be corrections, volatility and all sorts of gyrations. I keep dollar cost averaging in good and bad times.

  4. While the market has been irrational lately (I know, who would expect THAT) I am generally bullish. I think we may see some sort of pull back, but think it’ll be minor in nature. If we do have that pullback then I’ll be buying in more. I like to have a long term view of the market and will continue to invest. I think companies, in general, are doing fine and things do have the potential to run up more.

  5. This is why Dollar Cost Averaging is the best. Just keep investing through both times and your average returns should come out just fine.

  6. I guess the bubble or no bubble argument just depends on which financial indicators someone is going to use for the argument. You could watch one financial channel and get a bubble argument and then turn the channel for the opposite opinion. The problems this country has with growing debt (on all government levels), growing expenditures and our staggering unfunded future liabilities are going to eventually catch up with us.

    • That’s true, and part of the trick is learning the agenda of the ‘talking head’ and being able to separate out what portion of their argument relates to their agenda. You can spin anything.

  7. I think we’re in a long-term bull market, but that doesn’t mean there are going to be short term corrections. I think we’re seeing the start of it right now, and I expect the summer to be very weak in the market with the effects of the sequester really dampening consumer spending.

    I don’t think the Fed will end anything any time soon because metrics will get very weak this summer and everyone is going to wonder what happened…

  8. I don’t think we are anywhere near a bubble… when the dow reaches 19000 I might start to get a little concerned. But I think we’re heading into a very positive time for the markets.

  9. Hope you’re right. But in these parts, it’s hard to think of a monthly increase of ten grand as anything other than a bubble. Whatever it is, it sure ain’t normal!

    From what they guys in my business group report, interest rates are starting to rise. Rates on mortgages, for example, are slowly trending upward.

  10. There is always money to be made in the stock market. Bubble or not people will be cashing in. I am more long term and think that as the market has proven over 10-20+ years the returns work out. Of course investing in bad companies and not taking profits on huge gains is a big problem with many inverstors.

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