Bubbles are hard to define, because they can come out of nowhere and focus on any number of assets. “Bubble” is also loosely used to describe anything whose worth is below its value.
For instance, a number of investors and economists believe that higher education is a bubble. With the explosion of student loans and financial aid, universities have increased the price of attending by 260% (from 1980 to 2014), far outpacing inflation for the vast majority of other goods (at 120%).
Whether or not it’s a bubble, however, depends on a number of other factors. Is the student benefitting 260% more now than before? Are prices including other aspects of attending that may have improved 260% since 1980? Were universities undercharging before?
It’s difficult to say, as with any bubble.
Some are now calling the stock market as a whole a “bubble,” claiming that investors’ zeal for the Federal Reserve’s actions and involvement has misled them into over-buying the market and thus creating a bubble.
Let’s dive into the fun “numbers” stuff.
To begin with, the S&P 500 forward P/E ratio was 14 as of March 23 and was 25.88 by July 21.
Now, the regular P/E ratio is a current stock price over its earnings per share, while the forward P/E ratio is a current stock’s price over its predicted earnings per share. It is essentially a view of how “cheap” or “expensive” a stock is; the higher the forward P/E ratio, the more dollars you are paying to buy a stock for a given amount of future earnings. Even if the forward P/E ratio is an optimistic prediction, that’s a large jump from 14 to 25.88.
Where’s it coming from, though?
Digging deeper into the numbers, it’s clear that there are actually only a handful of stocks that are responsible for the majority of these returns.
The big ten are Microsoft, Apple, Amazon, Google, Facebook, Visa, Mastercard, Nvidia, Netflix, and Adobe. They are up 35% as a group since the beginning of the year. The other 490 stocks in the S&P 500 are down over 10%. In addition to that, as of now, three stocks, Apple, Amazon, and Microsoft, make up more than 16% of the S&P 500 Index and a third of the Nasdaq 100 Index. Together, they are worth $5 trillion with a ‘t’ dollars, larger than the economy of Germany and almost as large as that of Japan.
In addition to those startling numbers, there was a clear increase in the number of Google searches for the phrase “tech stocks,” thanks to the source Liz Ann Sonders.
What’s Next? Questions that need answering…
Okay, so now that we’ve compiled a lot of data on what the market is looking like, the next step is to sit down, think, and answer questions about the data.
Starting at the top, is the market overpriced, then? Or are there a handful of stocks that were considered to be safety stocks in a time of panic and are now overpriced as a result?
Another set of questions focuses on the two reasons a bubble can occur in a capitalist society: 1) because of scarcity and 2) because of efficiency, or as Charles Gave once famously termed them, jewels and tools. Jewels as in “there are very few of them” and tools as in “because they deliver great returns.”
So, are these large-cap technology assets jewels or tools? Do they have a monopoly or at least a strong hold on their sectors? Or did the COVID-19 crisis reveal that we are more reliant on technology than we think, and that technology will be the future of work, hence the flood into a small handful of leading tech stocks?
Scarcity, however, has never lasted long in traditional societies, especially ones that favor capitalism, simply because there is a rush into those sectors to snatch away the “extra earnings” of those companies. Other businesses will spring up to try to compete with them.
The question we started with, “is the stock market a bubble right now?” just proves, once again, that the market is still difficult to analyze at any given moment in time.
Like a photograph, sometimes we can’t see the whole picture, and all those other pieces that don’t make it into the picture are more important than we, as the photographers, think they are.