Why we're not in a 1990s-style stock market bubble

Valuation measures not in nosebleed territory but advisers see scope for pullback

May 16, 2013 @ 4:06 pm

By Dan Jamieson

As the stock market marches inexorably higher, some investors are growing worried that it has an onerous, 1990s-bubble-like feel.

But despite the market's lofty levels, current valuations aren't anywhere close to those reached in a true bubble period such as that of the '90s, observers said.

The best long-term market yardsticks — normalized price-earnings measures that take out short-term fluctuations in business cycles — show that the current market is about half as expensive when compared with late 1999 or early 2000.

Yale University's Robert Schiller popularized this smoothed approach with his 10-year cyclically adjusted P/E ratio. As of May 5, the CAPE ratio was 23.2, compared with a peak of 44.2 reached in December 1999.

Ed Easterling, president of Crestmont Holdings LLC, who literally wrote the book on long-term secular bull and bear markets with his 2005 treatise, “Unexpected Returns: Understanding Secular Stock Market Cycles” (Cypress House) also uses a 10-year normalized measure, which pegged the S&P 500 with a 22.4 multiple as of the end of March. By contrast, at the end of 1999, the index traded at a P/E of more than 45, Mr. Easterling said.

The market now trades at a P/E of 21, said Doug Ramsey, chief investment officer of The Leuthold Group LLC, a widely followed research firm that uses a 5-year normalized earnings measure. At its peak in March 2000, the market was at 37 times earnings, Mr. Ramsey said.

Still, there's good reason to be careful with equity exposure, considering the market's huge run-up since March 2009. The S&P 500 has gained 26.2% annually, including dividends, since hitting a low four years ago, according to data compiled by Bloomberg. The market made a similar advance during the last 50 months of the technology bubble.

As of yesterday, the S&P 500 had reached its most overbought levels in more than a year, according to Bespoke Investment Group, which noted that the index was trading at more than two standard deviations above its 50-day moving average.

“Stocks and indices can stay overbought for a long time, but historically, they have not remained as extended as the S&P is now for too long,” Bespoke warned in a blog post Wednesday.

“By the best measures, you can argue most [stocks] are moderately overvalued, but still some distance from bubble territory,” Mr. Ramsey said.

“I think what people are concerned about is that the market has more than doubled since 2009, with volatility low and without a huge correction,” Mr. Easterling said.

With the market “really steamed up here” and no meaningful pullbacks, it does feel overvalued, added Rob Francais, chief executive of Aspiriant LLC.

“But the fundamentals are a lot stronger today” than five years ago, prior to the financial crisis, he said. “Corporate balance sheets are much cleaner [and] there are a lot of stock buybacks.”

According to Bloomberg, profits at U.S. companies have grown 20% a year since 2009, twice as fast as during the dot-com advance.

In terms of market action, Mr. Ramsey said he was worried when small-cap stocks, cyclicals and financials all weakened in March.

“Those [sectors] typically weaken first,” prior to a market top, he said.

“Now, with this big resurgence, all of these lagging groups have caught up and they're making new highs” — a sign of more room on the upside, Mr. Ramsey said,.

Even Mr. Easterling, who believes that the market remains in a secular-bear phase, wouldn't be surprised to see stocks go higher over the next 12 to 18 months.

“Without something to change the trend, I'd expect more upside,” he said.

Bloomberg News contributed to this article.

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