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This Is No Bubble—It's an Unloved Bull
03/23/2011 11:38 am EST
Stocks are not expensive, but could get more so if the “fear premium” gets squeezed from oil prices, writes James Stack of InvesTech Research.
Birthday parties are supposed to be a celebration. Yet this bull market has to celebrate pretty much alone this month, in the midst of residual worries—and even newfound fears—that the market may crash.
The historical truth is that stock-market crashes do not come out of thin air. Every investment bubble—whether stock market, real estate-based, or otherwise—is accompanied by an easy to read fundamental and psychological condition, which is not present today.
More importantly, there are warning flags…usually lots of them. It’s just that investors are blinded by greed, or simply choose to ignore the danger signals.
While we may be in the latter half of this bull market (remember, average bull-market duration over the past 80 years is just 3.8 years), we are not in an investment bubble. In reality, odds remain high that we’re still in an unloved, disbelieved bull market.
And while another consolidation or correction is possible after the sharp run-up from last summer’s low, we do not believe the bull market is on its last legs.
There are two fundamental truths about bubbles:
- Every bubble, whether it was the stock market in 1929 or 1999 or the real estate market in 2005, has warning flags.
- Bubbles, for the most part, are invisible to those trapped inside the bubble.
Here's how to tell a bubble from a bull market:
Next: What This Means for Investors Today|pagebreak|
What About Today’s Stock Market?
First, we don’t see the same psychological ingredients of a bubble that we recognized on Wall Street in the late 90s and in the real-estate market in 2005.
It’s not that speculation can’t be found in some individual issues (i.e., Apple (AAPL) and Google (GOOG) both seem priced to perfection). But no one perceives the major risk as “not being on board”—and even among the bulls, expectations are relatively modest for 2011 and 2012.
Perhaps most importantly, valuations are nowhere near the extremes that would constitute the dangers of an investment bubble. In 1999, at the peak of the high-tech bubble mania, the S&P 500 Index sported a lofty price/earnings ratio of 33.9, based on trailing earnings.
Today, the same trailing P/E ratio for the S&P 500 Index is less than half of that level, at a moderate 16.9. The 80-year average valuation is 17.
In short, you can’t have a bubble if there’s no extreme valuation, because there’s no excess air to let out.
For now, we advise continuing to give the bull market every benefit of doubt. After a 20% gain over the past six months, further consolidation or correction would likely prove healthy for the market—especially if it helps bring down energy and commodity prices.
One important historical observation we want to make is that rising oil prices do not cause bear markets. More often than not, as shown in the graph below, oil prices rise in tandem with an economic recovery and healthy bull markets.
We also feel that the latest run in oil from $80 to over $100 is emotionally driven. There’s no evidence of a growing imbalance in supply and demand, and that means this psychological premium could quickly disappear if turmoil in the Middle East starts to simmer down.
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