Is the Stock Market a Bubble?

We agree that bubbles are rare, especially in financial markets. There was that thoroughbred horseracing bubble in the late 1980s, but let’s not go there. We also agree that bubbles lead to catastrophe. I am not arguing in favor of eternal bliss, but I am saying that we are not involved in a bubble that will lead to disaster of a Japan-like nature.

One thing that puzzles me is why the participation of individuals is in and of itself a harrowing thing. You cite the Forbes figure of 5 million online traders as though that is some indication of trouble ahead. Sometimes that kind of thinking smacks of clubbiness. The pros are a little irked that the individual has crawled in under the tent and is now running around with the kind of information that once was the sole purview of high-paid professionals. Certainly a subset of these individuals is behaving irrationally, but the same is true for professionals. It seems to me that the boys at Long-Term Capital did a lot more damage with their reckless actions than an army of individuals will ever be able to accomplish. But the wacky behavior of pros is rarely cited as a reason for concern. We often laud companies for giving every employee a piece of ownership in the firm through stock. We should also be unafraid that individuals are taking more control of their investments.

I do not forget the might of the Japanese as seen through American eyes in the late 1980s. I remember the movies, like Black Rain, or the book, Rising Sun, that painted Japan as an Uber-empire that would crush the U.S. into some kind of economic submission. But comparing the Japanese position then to the U.S. position today leaves out the impact of a confluence of beneficial events that the Japanese simply did not enjoy.

For starters, a great swath of the world went from a closed market concept (Communism) to a free market concept earlier in this decade. That occurred as U.S. companies were re-asserting themselves in the rapidly growing markets of technology and telecommunications. Moreover, the enduring expansion that we’ve enjoyed this decade dovetails with other postwar expansions. After World War I and World War II, the U.S. enjoyed the fruits of peace more than its bedraggled allies did. The same is occurring after the close of the Cold War.

Second, Japan worked from an export-dominated concept. Its home markets remain an enigmatic mystery. Problems with Japan’s home markets are at the core of its current post-bubble problems. The U.S. is not a similar one-note story. Not only is the U.S. enjoying a postwar-like expansion overseas, but its companies are enjoying the benefits of a huge and growing domestic market.

I think part of the problem for bubble thinkers is that the old concepts about inflation are not working anymore. Given the growth, given the tightness of labor markets, given the length of expansion, inflation should be perking up and making our life miserable. But it doesn’t seem to be happening, and this leads many bubble talkers to begin thinking something is seriously wrong with the economy and that we are somehow headed for a catastrophic endgame.

Economics is not a constant science, nor is history a perfect guide. And, often, generations of thinkers become obsessed with the most recent, nasty, scarring event. In the early 1950s, as the U.S. was embarking on a tremendous postwar expansion, the Senate held hearings to investigate the possibility of the next stock market crash. The happenings of 1929 were seared into the minds of people who had lived through that era. But no crash came during the 1950s, indeed stocks enjoyed tremendous gains during that time. In this era, we’re fixated on the stagflation nightmare of the 1970s. But inflation isn’t arriving on a 1970s schedule. Technology improvements have boosted productivity not only on an individual level, but also on a macro level. Corporations can more quickly maneuver to address bottlenecks and relieve inflationary pressures. These macro and individual increases in productivity are helping drive growth without inflation.

Yes, the stock market trades at a multiple to GDP. Leaving aside that Bill doesn’t really believe in government statistics, I think that the domestic GDP-to-stock market capitalization measure is outmoded by the massive internationalization of the marketplace. Big, successful companies aren’t reliant solely on domestic growth, but also on international penetration of markets. Corporations are more intricately involved in many national markets than ever before, making GDP-to-market measures not very meaningful in a historical context.

Also, Bill’s cant against stock splits underscores how the shifting sands are distracting bubble thinkers. Most bearish-leaning folks can’t believe that stock splits generate additional enthusiasm for stocks. What’s lost in that thinking is that companies who split their stocks are generally doing well and are signaling to the stock market that they anticipate things will continue to go well. They don’t split their stocks because they’re telling everyone that things stink. While there’s no fundamental change with a stock split, i.e., two pieces of paper get you the same piece of the company that a single piece of paper got you the day before, it is the positive declaration that brings investors in to snap up shares of a splitting company.