Remember when the Great Recession started? Remember how we heard almost daily about Big Banks being “Too Big To Fail”?
These banks that gotten so big, and amassed so much wealth that if they were allowed to fail (due to their poor investments in sub-prime lending and collateralized debt swaps (CDS)), it would cause the banking system and the entire economy of the United States to collapse. We were told that these banks needed billions (and then trillions) of tax-payer dollars to bail them out.
You’d like to think that after that initial bailout, our illustrious leaders would pass legislation that would actually prevent such a scenario from occurring again, right?
The number of banking institutions in the U.S. has dwindled to its lowest level since at least the Great Depression, as a sluggish economy, stubbornly low interest rates and heightened regulation take their toll on the sector.
The article goes on to state how Too Big to Fail may be a good thing, because it leads to less banks to oversee from a regulatory standpoint. But when regulations still allow the banks to invest is risky loans, and collateralize them into sub-prime Ponzi schemes, what difference does it make how many there are to regulate?
The problem is two fold.
Banks allowed to engage in practices other than lending. Think investment banks that take depositor’s money and ratchet up the risk by investing it in speculative ventures.
Too few banks. This leads to more single-points-of-failure in the banking system.
This isn’t rocket science.
More, smaller banks mean that when a bank fails, it is less likely to cause huge ripples that threaten the entire economy.
A banking system dominated by a few Too Big to Fail mega-banks means that if just one fails, then the whole system is affected and prone to cascading failure.
With the S&P 500 on a tear this year, more people are asking: “Is the stock market in another bubble?”
The possibility of another stock market bubble is a hot topic in financial circles these days, and it’s no wonder. The Standard & Poor’s 500 stock index (SPX) is up about 28% in 2013 (including dividends), and there hasn’t been a pull back or correction in over a year. This has many concerned about the return of “irrational exuberance.”
Still, others claim that the bull market is sustainable and there’s nothing like a stock market bubble today.
I’m not going to get in the weeds on this one, you can dig up details to support both sides. But here’s my 2 cents…
Why no stock market bubble
Most of the people who claim there is no stock market bubble state such things as P/E ratios not being near all-time highs, and current market valuations being supported by historic earnings.
They also point out that the new “record high” valuations in the stock market are only nominal, that is they are not record highs when adjusted for inflation.
Perhaps the weakest arguments that there is no stock market bubble I have seen are in the form of sentiment indicators.
Strategists at Wall Street brokerages — the so-called Sell Side — put their average stock allocation at 53.3% in November, up from 52.8% in October but still well-below the measure’s traditional long-term average stock weighting of 60%-65%.
For those unfamiliar with the “Sell Side Indicator”, :
The Sell Side Indicator is a contrarian gauge – a reading below 55 is bullish for stocks and doesn’t turn bearish until the consensus tops 65.
So, they’re basically using a sentiment indicator to argue there is no stock market bubble and the S&P 500 will go higher still.
Maybe. But sentiment can turn on a dime. Sentiment is an indicator of Mr. Market’s emotional mood, and I’m not willing to hang my retirement savings on the mood of a certified manic-depressive, thank you very much.
Other arguments against a stock market bubble run along the lines of “stocks can go higher, because they’ve been going higher for 5 years now.”
These people usually go on to point out that the “average bull market” runs for 7 years, so we still have 2 more years before this bull is long in the tooth.
Maybe. But doesn’t the average of 7 years mean that there are just as many bull markets that die before 7 years as after?
Besides, stocks can continue to rise even during a stock market bubble. Everything is fine, until it isn’t. The point is that a stock market bubble is a fragile thing, and it doesn’t take much of a catalyst to pop it. Everything looks fine until that catalyst appears, and then it’s painfully obvious there was a stock market bubble all along.
This time around, that catalyst might be the Federal Reserve announcing a tightening of the easy money policy (the so-called ‘taper’). Or it might be bickering in Congress. Or the European “recovery” going off the rails. Who knows? The point is that stock market bubbles are fragile and prone to burst when least expected.
There are many more detailed arguments that there is indeed another stock market bubble, but I thought It’d be more impactful to use some simple charts that got me thinking more about another stock market bubble.
Take a look at these, and decide for yourself if the idea of another stock market bubble has merit:
Here’s a chart of the S&P 500 over the last 5 years:
You can see that for most of the past 5 years (except a brief pull back in the beginning) it’s been a pretty smooth ride. Predominantly upward, but not like a roller coaster.
Here’s a chart of the S&P 500 since the recession began in 2008/2009:
This presents a pretty compelling argument that there is no stock market bubble at this time. There’s quite a bit of choppiness, and the current value is not much above the value in 2008, before the crash.
In fact, if you were to adjust for inflation, the S&P 500 looks to be about flat for the time period.
But take a look at what happens when we zoom out even further on the time scale:
That’s the S&P 500 from 1950 to today.
I don’t know about you, but it sure looks like something different started happening around 1995. And to paraphrase Bob Dylan:
Look out kid, it’s something they did
God knows when, but they’re doing it again.
Actually, we do know what, and when. In 1995, the Federal Reserve Chairman (Alan Greenspan) began unleashing unprecedented liquidity in the market. His easy money policy blew the dot com bubble (the first almost vertical ramp up in the chart above). After that crashed, he increased liquidity and caused the housing bubble (which in turn led to the second climb and crash in the chart above).
Since Ben Bernenke took the reigns at the Federal Reserve, he has continued Greenspan’s policies – on steroids!
Take another look at that last chart. Don’t focus on how high the peak is. Instead, look at how steep the rise is. In essence, how short a time it took the stock market to get to where it is. It’s looking eerily similar to each stock market bubble of the last 20 years.
Stock market bubble conclusion
Personally, I think that you don’t have to have record high valuations for a stock market bubble, you just need valuations that are too far ahead of the underlying fundamentals.
I think that’s where we are.
Does anyone living outside of Wall Street and Washington, DC honestly believe the real economy is growing at a rate that justifies that sort of escalation in the S&P 500?
I think the easy money from the Fed, and punitively low interest rates have fueled another stock market bubble. If we don’t get a correction soon, we look to be heading toward yet another “once in a lifetime” sort of crash.
But I’m not a professional, so don’t make any investment decisions based on anything I tell you.
Shoppers should be sure to read the return policy this year. That’s the warning from a recent article in Kiplinger.
Some stores are curtailing the length of time shoppers have to return items, while others are not accepting returns on clothing once the tags have been removed.
This last example is in the hopes of combating “wardrobing”, or the practice of buying, using and then returning a product for a refund. Bloomingdale’s is one such retailer “tagging its apparel with conspicuous plastic tags. If a tag is removed, shoppers can’t return the item.”
In short, if you hope to return an item, you had better keep the receipt and only return it if you haven’t already used it.
“Retailers want to identify the bad actors. To do so, some companies are gathering data on customers who return merchandise, watching for suspicious patterns and warning or denying repeat offenders. Clerks may ask for state-issued identification, such as a driver’s license, before you can make a return. Nearly 10% of retailers require ID for returns made with a receipt, and 73% require ID for returns made without a receipt. Some scan the ID into their own system; others send the info to a third party. If you exceed a retailer’s limit for the number of returns within a given time frame or for the value of returned products, you could be denied more returns for a period of time (typically 90 days). If you are given a warning or denied a return, the Retail Equation, a company that collects return information for 27,000 merchants in North America, will provide you with the information in its return-activity report over the phone. To request your report, visit www.theretailequation.com/consumers.”
Kiplinger’s calls these stores implementing tougher return policies “stingy”, but are they really? I mean, aren’t such things common sense? Shouldn’t people be expected not to game the system? Isn’t wardrobing dishonest to begin with?
Regardless of what you think of Peter Schiff, you have to admit that this video illustrates perfectly one example of how the Efficient Market Theory is just that – a theory. Not only has it not been proven, but one could argue that examples like this (and the dot-com bubble, and housing bubble) actually disprove the Efficient Market Theory.
This video is Peter Schiff making the rounds on financial media, presenting his case for why the Federal Reserve would not taper (that is, decrease the amount of money it is pumping into the economy) at a time when all the talking heads and 90+% of economists had a consensus that there would be a taper (they just disagreed on how much the money pump would decrease). NOTE: This was in relation to the proposed taper in September of 2013.
I think this is relevant to the Efficient Market Theory because Efficient Market Theory says that the market is always right, and always pricing all knowable information. The possibility that the Federal Reserve would not taper was simply ignored by the market, and so when the Federal Reserve announced “no taper”, the market cracked.
To be clear, the prospect that the Federal Reserve would chose not to taper is not some unknown unknowable. It was clearly a possibility, just not a fashionable one.
So without further ado ladies and gentlemen, I present group-think on parade:
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