Learn To Invest
Stocks Special Reports LICs Credit Funds ETFs Tools SMSFs
Video Archive Article Archive
News Stocks Special Reports Funds ETFs Features SMSFs Learn
About

News

Is the US stock market in a bubble?

John Rekenthaler  |  03 May 2018Text size  Decrease  Increase  |  
Email to Friend

Apple iPhone X

No matter what reasonable valuation measure of US stock market valuation that one selects, it will show prices to be high. Major global technology stocks could be overpriced. But bubbles don't immediately pop. Sometimes they linger for several years. Justice does not always come swiftly.

One common valuation measure is forward-looking price/earnings (P/E) ratio. Morningstar calculates that figure by dividing 1) share price by 2) forecast earnings for the current financial year. These results can then be rolled up to give a stock market's aggregate figure.

The S&P 500's figure is currently 17. In spring 2017, it was just below 20. Three years back it was 18, and five years ago it was 14. Rather than describing a bubble, the forward P/E ratio appears to indicate "market as usual".

However, these forward P/E levels are not new. From the 2008 stock-market crash through 2015, forward P/E ratios were consistently lower than today's, but not that much lower, averaging about 14. Surely the difference between 17 and 14 does not constitute a bubble. What's more, the S&P 500's forward P/E ratio was 18 in 2003, and nobody calls that year a bubble, given that stocks were recovering from losses.

Forward P/E ratios are one way to judge stock prices. Other approaches could yield different conclusions. By selecting the measures that support bears’ cases – as I did myself when choosing forward P/E ratios – you can raise concerns about current stock prices. But they would be hard-pressed to demonstrate a bubble.

Some tech companies may justify valuations

I don't see a bubble – certainly not with the overall US stock market. At a time when 10-year Treasuries pay 3 per cent and annual inflation hovers around 1 per cent and 3 per cent, stocks are not dear when compared with the alternatives. At some point, of course, the economy will turn; those P/E ratios will spike because earnings collapse; and stocks will get it hard. But the same could have been written in 2012, and 2013, and so forth. Without further evidence, why believe this year is different?

With global technology stocks, the bubble claims may be on firmer ground. It is indeed true that the leading companies must grow their businesses dramatically to justify their stock prices. Sometimes, such minor miracles occur.

For 15 years, sceptics argued that Apple's and Amazon.com's share prices have assumed unrealistically strong business fundamentals. So far, so wrong. Often, though, a glamorous company's business fundamentals don't match the expectations. Perhaps now is that moment for the giant tech leaders.

But the thing is, real bubbles aren't modified by the word "perhaps". In my 30 years at Morningstar, I have encountered only two true bubbles in the stock and bond markets: speculation that led to what I regarded as obviously inflated security prices, accompanied by what appeared to outsiders as a mob mentality among buyers. One was Japanese stocks in the 1980s; the other, US tech firms in the late 1990s. Even at the time, I felt that doom was inevitable.

Not so with today's leading tech companies. They are expensive, certainly. That said, those companies have real, dominant businesses. It is possible, if not necessarily probable, that their business growth will match the sky-high expectations and they will continue to outperform other stocks. Even if that doesn't happen, there is a good chance that their returns will be positive.

Many bubbles are proclaimed, but few arrive. The word is not useful; rather than signal something extraordinary, it has come to mean "securities I don't like because they strike me as being too expensive".

More from Morningstar

ETP inflows may benefit from financial adviser backlash

• Is this a bubble bursting?

Make better investment decisions with Morningstar Premium | Free 4-week trial

 

John Rekenthaler is vice president of research for Morningstar, based in the US. He is a columnist for Morningstar.com and a member of Morningstar's investment research department. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

 

is vice president of research for Morningstar.

© 2020 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

Email To Friend