ARE THE STOCK MARKET AND ECONOMY IN A BUBBLE? 7 FACTOR EXPLANATION
I recently summarized Dalio’s last book, Big DEBT CRISES and there he shares his questions, check list, to see whether the stock market or economy is in a bubble or not. In today’s article, in light of the FED’s tightening, we are going to go through his questions, to see whether we are in a bubble or not.
my name is Sven Carlin and I am an independent investor, independent thinker who doesn’t really like to follow the crowd, that has served me well in my life and, I have the feeling it will serve me well in the future too. Let’s go through Dalio’s questions one by one and then conclude with what to do, where Dalio’s option is to have an all-weather portfolio.
We are going to look at whether the US economy and stock market are in a bubble. As for Europe, I’ll make a special article about it due to the many economies.
PRICES ARE HIGH RELATIVE TO TRADITIONAL MEASURES
The US stock market is expensive and prices are much higher than traditional measures.
A look at the cyclically adjusted price to earnings ratio for the S&P 500 that takes into account 10 years of earnings, shows how stock prices were higher only during the dot-com bubble. But, let’s not focus only on stocks, let’s look at housing.
The home price to income ratio is not higher than it was in 2007 but is getting close to it and it is much higher than it was in the past 50 years. Incomes were low in the 1950s so that isn’t really comparable.
To answer question one: yes, prices are high relative to historical measures.
2. PRICES ARE DISCOUNTING FUTURE RAPID PRICE APPRECIATION FROM THESE HIGH LEVELS
If we take a look at the S&P 500 and at S&P 500 forward expected earnings, all we can see is fast growth.
So, perhaps what we have seen up to December of 2017 will again be called a bubble as higher interest rates inevitably put pressure on asset prices. Not yet on stocks as the sentiment is still strong but you can’t escape when it comes to housing.
ANSWER: YES, prices are discounting fast future price appreciation, certainly in stocks, whereas it might be over for housing.
3. THERE IS BROAD BULLISH SENTIMENT
Let’s see, Kudlow states the US economy is crushing it.
The middle class left after 2008, typical behaviour, buying high and selling low. If we see another bump like in 2007 where the participation jumped from 61% to 65%, we will know it’s a bubble. Those aged 35 and above are investing a bit but not yet like it had been the case.
Answer: with stocks it is a no but with houses it is a yes. Also, it is important to note the widening wealth gap where those that have invest more and push stocks higher while those that don’t have, simply don’t have to invest.
7. STIMULATIVE MONETARY POLICY THREATENS TO INFLATE THE BUBBLE EVEN MORE (and tight policy to cause its popping)
Interest rates have been already tightening and we can expect more in December.
We are at bubble top – so a lot of opportunities to diversify by selling what is in a bubble and buying what is in depression. In a global world you can do that today.
If you wish to check how am I building my portfolio as I cashed out of most my long investments during 2015-to 2018, the last being Nevsun – you might want to check my Stock market research platform where I am slowly building my model portfolio that should do very well in this environment.