Has there been a general stock market bubble in the US in the past 20 years?

[alfred russel]

Prompted by a recent post by Yi, I looked up some numbers.

I used the Dow Jones Industrial Average (mainly due to Greenspan's testimony--I think a broader index like the S&P 500 would show the same thing). I ignored dividends and inflation. I think of 3 key "bubble" dates:

Greenspan's "irrational exuberance" testimony to congress
the late 90s "tech bubble"
the recent economic meltdown

I took the high mark from each of those events (by reading charts from Yahoo finance, could be off a bit), as a worst case investment dates, and compared it to the current price the DJIA is expected to open tomorrow (17,451).

If you invested on the date Greenspan gave his testimony, 12/5/96, the DJIA was 6,382 and you would have an average compounded return of 5.56%.

If you invested on the peak moment of the "tech bubble", 12/1/99, the DJIA was 11497 and you would have an average compounded return of 2.71%.

If you invested on the peak moment before the recent economic crisis, 9/1/2007, the DJIA was 13,930 and you would have an average compounded return of 2.91%.

So, while those may not be great returns, I think if you want to argue they were general times of "bubbles" in the stock market, that also implies we are in one right now.

[Siege]

I think you are right.

[Admiral Yi]

Earning typically go up, so it would make more sense to compare P/Es than just prices.

And the tech bubble didn't affect the Dow at all AFAIK.

That said, S&P is trading at 25.4 P/E, while Yuro stocks are trading at 14.7.  That's why I'm only buying Yuros right now.

[alfred russel]

Earning typically go up, so it would make more sense to compare P/Es than just prices.

And the tech bubble didn't affect the Dow at all AFAIK.

That said, S&P is trading at 25.4 P/E, while Yuro stocks are trading at 14.7.  That's why I'm only buying Yuros right now.

So you are saying there is a bubble now?

P/E is a rather crude measure that is not so comparable across time as industries and accounting rules change.

[The Minsky Moment]

I suspect stocks are high for lack of other options.  Bond yields are very low and the future prognosis for bond prices looks poor, junk credit risk is priced very tightly, corporate treasuries are shying away from real investment and pouring excess cash into share buybacks.

[Admiral Yi]

What Joan said.  We are victims of financial repression.

[Baron von Schtinkenbutt]

And the tech bubble didn't affect the Dow at all AFAIK.

Indeed.  The Dow never bubbled, and thus never crashed.  That was a function of the bubble being driven by IPOs, though, which don't really affect the Dow.

Incidentally, the NASDAQ has grown about twice as fast as the Dow since the financial crisis, though both have been on a fairly consistent rise.

[alfred russel]

Stock valuations don't just involve predictions of future earnings/cash flows, they also involve predictions of risk premiums and interest rates.

If you are overly optimistic about future cash flows because you don't see the economy is built on bad debt, but at the same time you are overly pessimistic about interest rates, it is possible that your stock valuation is still fair. Ie, no bubble.

I didnt' read the book, but I understand the guy that wrote "DOW 36,000" and was widely ridiculed was primarily focused on what he considered the excessive interest rate used to discount future stock earnings.

[The Minsky Moment]

There's a lot in the finance literature about equity risk premia being too high given historical performance and "rational" behavioral models.

[MadImmortalMan]

"rational" behavioral models.

Stock valuations don't just involve predictions of future earnings/cash flows, they also involve predictions of risk premiums and interest rates.

If you are overly optimistic about future cash flows because you don't see the economy is built on bad debt, but at the same time you are overly pessimistic about interest rates, it is possible that your stock valuation is still fair. Ie, no bubble.

I didnt' read the book, but I understand the guy that wrote "DOW 36,000" and was widely ridiculed was primarily focused on what he considered the excessive interest rate used to discount future stock earnings.

It's a good point, but I'm not so sure it's a great idea to automatically assume ZIRP is the new normal, even though it's been around a long time. There may well be a very long term-shift, but remember the bond market is enormous compared to the stock market. And there's a lot of potential energy built up in there. It could just as easily whip that tail in the other direction for a couple decades.