5 signs the stock market is in a bubble
(MoneyWatch) U.S. stock markets have had a good year so far, but has it been too good?
The Standard & Poor's 500 is up 24 percent in 2013, after rising 13 percent last year, while the Dow Jones industrial average is up nearly 5 percent since the beginning of May. Some stock watchers think that rise, which extends a bull market that started in 2009, is unwarranted because growth in the U.S. and overseas remains sluggish. The onslaught of headlines focusing on stocks hitting new highs seems to ignore the grimmer realities minimal job growth and eroding consumer confidence. Even the government shutdown didn't slow the party.
So are stocks in a bubble? Here are a few things to keep in mind:
There's too much money in the system. Larry Fink, CEO of giant money manager BlackRock, clearly thinks the market is frothy. "We've seen real bubble-like markets again," he said at a panel discussion this week, according to the Bloomberg news agency. "We've had a huge increase in the equity markets."
Fink and many others are concerned about the impact of the Federal Reserve's "quantitative easing" program, under which the central bank is buying $85 billion a month in government bonds and mortgage securities in hopes of stimulating economic growth. These assets have vastly expanded the Fed's balance sheet, including recently. Since Sept. 4 alone, those balance sheets have increased 4.3 percent, while the S&P 500 has increased 4.9 percent.
In other words, investors are doubling down to capitalize on the cheap money that continues to flood the market.
Interest rates have been too low for too long. The Fed's policy of keeping interest rates ultra-low has encouraged some problematic investor behavior. First, it means that traditionally safe investments like U.S. government bonds pay very low interest rates. This makes investors look for better returns in other assets, like the mortgage-backed securities which contributed to the financial crisis five years ago. Today that asset could be stocks, raising the risks that any bubble in equities could suddenly pop.
Second, low interest rates make it attractive to borrow money for investment purposes. In September, investors took out a record amount using their brokerage accounts as collateral to get those loans. According to the New York Stock Exchange, investors borrowed more than $401 billion, surpassing April's record of $384 billion. That was a 4.8 percent increase from the previous month, the biggest single-month jump since January.
Rising levels of debt are frequently seen as a sign of increasing investor confidence. But it can also be a sign of excessive speculation, especially when that money is re-invested in stocks. Under these conditions, stocks rise mostly because people with borrowed money are buying them, not because of fundamental growth in the economy.
Not many people are buying stocks. This may seem counterintuitive to the last point, but it isn't. Since 2009, the volume of shares being traded on the major U.S. stock exchanges has decreased every year. As a result, it doesn't take a lot of activity to move stock prices up.
Corporate profits are increasing, but revenues aren't. As of Monday, 49 percent of companies in the S&P 500 had reported results for the third quarter of this year. And according to a report from FactSet, "The percentage of companies reporting earnings above estimates is above the four-year average, while the percentage of companies reporting revenue above estimates is below the four-year average." This suggests earnings are increasing not because companies are growing, but because they are cutting costs and buying back stock. There is a limit to how long they can continue to do this.
Copper prices are falling: Historically, the price of copper has followed prices on the key stock exchanges. That's because copper is an industrial metal, and increased demand for the metal means companies are producing and selling more things. That, in turn, tends to boost the value of companies and their stock.
Here's the thing. Since 2011, copper prices have steadily dropped even as stocks have continued to climb.
The financial markets have long been seen as reflecting future economic activity. In short, if the markets were going up, then the economy was also going up, or would be soon. But it is getting increasingly difficult to make the case that the markets as they are now reflect anything but themselves.
