One needs look no further than the U.S. market that has seen the S&P 500 advance 51.68% from its March 9th trough as of 8/21/09. The more volatile BRIC markets (Brazil, Russia, India and China) have advanced by an average of 59.83% during the same period.
In recognition that markets are subject to short term fluctuations based on technical patterns such as overbought and oversold levels, and also with regard to the fact that September is historically the poorest performing month in the U.S. stock market, how “safe is the water” for taking advantage of a potential pullback to put additional cash to work? (According to Bespoke Investment Group data, September and February are the only two months that have seen a negative average monthly return for the Dow Jones Industrial Average over the past 100 years.)
In trying to answer this question, Standard Chartered Bank U.S. Economist John Calverly's “Checklist of Bubble Characteristics” is a useful tool. This was published in his 2004 book Bubbles and How to Survive Them when the author was Chief Economist at American Express Bank.
Checklist: Typical characteristics of a bubble (assessment by the author of this comment in italics)
1. Rapidly rising prices » stocks yes, housing no, commodities no
2. High expectations for continuing rapid rises » no
3. Overvaluation compared to historic averages » no
4. Overvaluation compared to reasonable levels » no
5. Several years into an economic upswing » no
6. Some underlying reason or reasons for higher prices » prices still below highs
7. A new element, e.g., technology for stocks or immigration for housing » no
8. Subjective “paradigm shift” » no
9. New investors drawn in » no
10. New entrepreneurs in the area » no
11. Considerable popular and media interest » no, still fear and doubt
12. Major rise in lending » no
13. Increase in indebtedness » no, savings are rising
14. New lenders or lending policies » perhaps central banks
15. Consumer price inflation often subdued (so central banks relaxed) » yes
16. Relaxed monetary policy » yes
17. Falling household savings rate » no
18. A strong exchange rate » no
Source: John P. Calverly, Bubbles and How to Survive Them, p.13.
No apparent bubble in Emerging Markets:
As of August 18th Global Emerging Markets (GEM) had rallied 56% since OECD lead economic indicators troughed in December 2008, making the current rally about twice the average seen after previous episodes when OECD lead indicators troughed. However, the trough valuation for GEM in December 2008 was 1/3 lower than in previous cycles, and GEM valuations are only now at just 5% above their average when lead indicators bottom.
GEM Historical P/E – now versus previous cycles when OECD leading indicators troughed
Source: Datastream, OECD, Credit Suisse Estimates published in Credit Suisse Asia Daily 8/18/2009
No apparent bubble in U.S. Equities:
In the U.S., stocks have advanced by 51.68% from their March 9th closing low as of 8/21/2009 according to Bespoke Investment Group. This naturally causes worries about a bubble. However it appears far premature to give this label to the present market.
The S&P 500 valuation now resides at 18.89x 2009 using Standard & Poor’s current $54.40 bottoms up S&P 500 operating earnings forecast. For perspective, the same multiple of operating earnings was consistently in the high 20’s during 1999 through the first half of 2000 as the S&P 500 was topping out at the peak of the last bull market. For even further perspective, a look back to the Nifty 50 era of 1972 shows that the original Nifty 50 traded for between 46 and 92 times earnings according to Forbes magazine. Therefore it seems that there is plenty of scope for stock valuations to move higher before we can be considered to be in a bubble; particularly if there is a steady diet of positive news flow.
No apparent bubble in Investment Grade Corporate Bonds:
As highlighted by Argus Research on August 24th, as of July 31st the average yield spread between a AAA-rated corporate bond and the U.S. Government long bond was 185 basis points. Over the past 55 years this spread has averaged 80 basis points. For BBB rated bonds, the average spread was 353 basis points as of July 31st, versus a historic average of 178 basis points (as published in Argus Market Watch 8/24/2009).
Conclusion:
With few conditions for a bubble present, and financial markets exhibiting inexpensive to normal valuations, there are no signs of a bubble in any of the aforementioned risky assets – U.S. stocks, emerging markets stocks or corporate bonds.
Absent an external shock such as a terrorist attack, or significant problems with a major trading partner, and assuming continued improving economic news, stock and corporate bond markets offer scope for solid returns from these levels despite the healthy advances of the recent past.
Important Legal Information:
Past performance is no guarantee of future results. Investing involves the risk of loss. This material should not be used as the basis for investment decisions on its own. Prior to investing, an investor should assess the specific risks of given instruments and determine (with his or her professional advisors) if the investment is suitable for his or her circumstances.
Taylor Thomas 8/30/2009
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