Is the Stock Market a Bubble?

I hadn’t realized that Slate readers were so fond of guns and canned food. There’s no other way to figure that 80 percent of the readers of this debate believe the stock market is in a bubble. Yes, Bill Fleckenstein makes some good arguments about lofty valuations, but he falls flat when it comes to arguing that the U.S. stock market is due for a catastrophic bubble that would lay waste to our nation’s economy for the next decade as the bubble-popping did to Japan this decade.

Already having outlined the fundamental differences between the U.S. now and Japan then, I will wade back into the issue at the core of the Fleckenstein bubble case. Earnings. He argues that earnings growth is nonexistent and therefore stock values have soared to bubblelike levels on little more than hot air. According to my figures, 1998 was not a great year for earnings growth. The S&P 500 aggregate earnings per share rose from $44.74 to $44.87. That’s not a wild jump. At the same time, stock prices moved up about 25 percent, as measured by the S&P 500.

Again, the issue at hand is not so much the pace of earnings growth, but the durability of that expansion. In 1998, we managed to muster a tiny bit of growth in earnings even though we experienced some hideous events that will not likely repeat themselves. Oil prices were practically cut in half (Brent Crude went from $17 a barrel to about $10 a barrel). That meant the huge energy group wasn’t helping the overall earnings picture. GM suffered from a strike to the tune of a couple billion dollars. Financial companies took heavy hits in the third-quarter selling panic. Yet even with all that, earnings edged higher.

The key to all this bubble chatter is this year. And this year is looking like it will be a year for growth. Indeed, even the pessimists on Wall Street, people like Chuck Clough of Merrill Lynch, are increasing their earnings estimates for 1999. Mr. Clough has taken his prognostication for S&P 500 earnings from the negative column into the positive column–arguing for earnings growth, not an earnings decline. The folks at PaineWebber argue that growth for S&P 500 earnings will be in the high single digits. These aren’t estimates from the wild-eyed industry analysts; they’re tough-minded views offered by top-down thinkers.

So earnings are growing and inflation is anemic. That combination of continued growth and low inflation argues directly against any bubble theories and in favor of this stock market.

And let’s talk about one more important factor, demographics. The boomers are pouring money into the stock market. And they will continue to do so at an awesome clip for many years to come as they race to prepare for retirement. This fire hose of liquidity is one more reason that the catastrophic bubble argument is all wet.

Despite the enthusiasm for the bubble theory, the camouflage-wearing, bean-eating, gun-toting, doomsaying crowd can, in full cry, only articulate good reasons for stocks to go down a little bit. Bubble? Arguing for such catastrophe ignores the seismic changes going on before our very eyes. The explosion of efficiency driven by technology alone is enough to support the stock market’s move in the past four years. The Internet is revolutionizing how consumers conduct their daily lives–and consumers are the heart of the U.S. economy.

The bubble thinkers are wrong. They believe we are stuck in an old world, a world governed by inevitably high inflation and booms and busts. They believe technology-driven productivity gains peaked with the internal-combustion engine. They believe that the Internet is no revolution but simply an overrated CB radio for our generation.

I don’t believe those things. I believe that earnings are growing, that inflation is dead–skewered by the Internet. Technology has also created a world in which large corporations will move with incredible alacrity to address imbalances in their businesses. This is the kind of mega-productivity gain that has played a vital yet little understood role in the stock market boom. Stock prices, while from time to time ahead of themselves, are ultimately reflecting the new reality of low inflation and steady, stable growth as the world moves inexorably toward a more open, more American-style capitalism. As for bubbles, you’re more likely to find them in your Y2K champagne than in the stock market this year.