Traders wearing masks work inside posts, on the first day of in-person trading since the closure during the outbreak of the coronavirus disease (COVID-19) on the floor at the New York Stock Exchange (NYSE) in New York, U.S., May 26, 2020.
Brendan McDermid | Reuters
Bluster about bubbles is blowing through Wall Street again, stirring investor passions and kicking up enough dust to cloud investors' view of the market's message.
Stocks' surge off the panicky March lows has been so fast and dramatic alongside an economy only slowly emerging from a pandemic shutdown, that observers have insisted the only explanation is an irrational collective speculative furor pushing asset values away from economic realities, enabled and emboldened by an aggressively easy Federal Reserve.
Last week long-tenured value investor Jeremy Grantham in a CNBC interview called the U.S. stock market a "Real McCoy bubble," the fourth of his career, citing extreme valuation and rampant speculation in financially sketchy stocks. His danger warning followed those of esteemed hedge-fund managers Stanley Druckenmiller and David Tepper, who likewise compared the current market to the bubbly culmination of the late-'90s stock mania (before partially retracting those calls).
Oaktree Capital founder Howard Marks, a widely followed thinker on markets, released his latest investor letter last week, detailing the factors driving the embrace of risky assets since March and insisting, "fundamentals and valuations appeared to be of limited relevance" in the rally. "In all these ways, optimistic possibilities were given the benefit of the doubt, making the terms 'melt up' and 'buying panic' seem applicable."
Near the center of seasoned investors' alarm over the market action is the recent burst of small amateur trading activity, centered on clients of the zero-commission Robinhood app and the real-time trading commentary of Barstool Sports founder David Portnoy - whose cheeky motto "Stocks only go up" has been embraced by those racing into beat-up travel stocks and, notoriously, the shares of bankrupt car-rental firm Hertz.
There is at least a vein of truth in all these complaints. With the S&P 500 down a mere 8% from its February peak despite a quadrupling of the unemployment rate and collapse in earnings forecasts, stocks have indeed run far ahead of present economic realities in pricing in a sharp rebound.
20-year high valuation
Equities do look pricey, with the S&P at 22-times forecast earnings for the next 12 months, near a 20-year high. The Fed's vow to keep short-term rates at zero for years and its forceful move to buy corporate bonds have absolutely compressed risk spreads and encouraged investors to accept slim compensation for shouldering credit risk. Investment-grade corporate yields sank under 2.2% last week, which quite directly helps explain stocks' elevated valuation.
As for the Robinhood, speculative-trading phenomenon, some of it surely seems overheated and lacking in rigor. That some investors seemed willing to buy Hertz stock as the company contemplated selling new shares that had a high likelihood of becoming worthless in the bankruptcy workout makes little objective sense.
But in itself it doesn't reflect anything particularly new or, in itself, dangerous to the broader market. There have always been small investors looking to turn a quick buck by playing fast-moving risky stocks. In the '80s there were dozens of penny-stock brokers plying this ground. In the '90s, online brokers made it cheap to flip stocks and day-trading parlors proliferated, while financial columnist Dan Dorfman would whip stocks around each day with his midday CNBC pronouncements.
Yet the scale and underpinnings of the present trading boomlet – and the generally appalled and scolding reaction to it by Wall Street pros – keeps it from representing anything like a pervasive bubble posed to obliterate unassuming investors.
CNBC's Jim Cramer last week cogently took the bearish billionaire bubble-callers to task for their prophecies of doom that could dissuade smaller investors from participating in the market – participation that, yes, often brings tough but useful lessons in short-term loss.
Doesn't match past bubbles
Typical features of a bubble include pervasive optimism about future profits, heavy flows into stocks without regard to valuation and massive share issuance by new companies – all animated by "New Era" delusions and driving unchecked momentum in prices.
What do we have now? Persistent skepticism by traditional retail investors, as gauged by the predominance of bears over bulls in recent American Association of Individual Investors surveys. More money flowing out of stock funds than in over the past few months. A sense among the public that "everything has changed" as a result of the Covid-19 epidemic – but not for the better.
Critics love to invoke 1999 as a template for what they see as a tenuously expensive and speculative market now. But there's no real comparison.
The Nasdaq 100, dominated by the most profitable companies on the planet, today trades for 28-times expected earnings, versus 80-times in '99. Oppenheimer technical strategist Ari Wald notes that the NDX is up 125% the past five years – which is how much it gained in the 12 months leading to the March 2000 bubble peak.
Sure, there have been some opportunistic secondary offerings recently by retail-trader favorites Nikola and DraftKings. But in 1999, there were more than 500 IPOs and their average first-day stock pop was above 60%.
Since 2000, after which the Nasdaq fell some 75%, commentators have been quick to cry "bubble." Early in the 2003-2007 bull run, it was common to cite an "echo Internet bubble" after Google's IPO, when in fact it was the enduring growth of Web 2.0.
There is no doubt that stocks doing well while the economy reels with some of the worst labor and manufacturing data ever collected is a matter of some dissonance. But this isn't new.
For years after the March 2009 bear-market bottom, skeptics cited the Wall Street-Main Street disconnect, as in this chart widely circulated back in 2010. The market kept rising for years thereafter – with several stumbles along the way, sure, but none of them devastating.
Even the character of the Robinhood/Portnoy trading dynamics work against the notion of a bubble. It arose from an opportunistic reaction to a moment of devastation, with many stocks priced for extinction, not from assumptions of everlasting and effortless growth.
There's something even fatalistic about it – individuals stuck at home, with small amounts of spare cash and embracing the freedom of "nothing left to lose," in part by betting on one last act for distressed or doomed companies. Not exactly a sky's-the-limit bubble mentality.
Make no mistake, current valuations appear aggressive. The frenzy for corporate bonds, reliant on a Fed backstop, might be underpricing risk to a degree. And short-term readings on trader sentiment, including rare extremes of bullishness among options traders, indeed leave the tape vulnerable to air pockets and corrections.
Yet there's a big difference between a market priced for subpar long-term returns that's susceptible to some downside gut checks along the way, and a genuine bubble that distorts capital allocation and foretells profound losses for years to come.
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The stock market may be pricey, but it's nothing like the genuine market bubbles of the past - CNBC
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