Like the mother
of a bride reviewing flower arrangements and fretting that a brilliantly sunny
day could be marred by dark clouds hidden just beyond the horizon, pundits have
been parsing the exceptional year-to-date performance of U.S. stock markets and
fussing over the future.
It’s true. U.S. stock
markets look like they may be headed toward a fizzy champagne finish even after
retreating a bit last Friday. Through Thursday, the Dow Jones Industrial Index
had closed at record highs 50 times this year and the Standard & Poor’s 500
Index wasn’t far behind with 44 record high closes, according to NASDAQ.
U.S. stocks
aren’t the only markets analysts are stewing over. They’re also pondering the potential
effects of higher interest rates. Last week, the yield on benchmark 10-year
Treasury notes ascended beyond 3 percent for the first time since 2011. It’s
possible higher yields (and a potential drop in bond values) will cause
investors to seek out better performing assets next year, but that may not be
all bad, according to Barron’s.
“IS TOPPING 3% A
BAD THING? Not necessarily, considering the reason for the 10-year yield's
march higher: the Federal Reserve's decision to taper $85 billion a month in
Treasury purchases, starting with $10 billion less in January. It's a small
paring, but sends a big message: Maybe – just maybe – after years of recovery,
the U.S. economy is returning to normal.”
Returning to
normal in the United States may not prove to be any easier than seeking a new
normal in China. Top communist party leaders in China recently implemented
policies that give markets a more significant role in the country’s economic
development. Concern that high levels of local government debt could pose a risk
to ongoing economic growth has the People’s Bank of China (PBOC) employing some
unconventional measures to manage interest rates.
Last week, those
actions caused China’s seven-day repurchase rate to rise precipitously which triggered
the worst case of interbank jitters since June’s liquidity crunch in China. The
PBOC “injected fresh money into the markets on Tuesday, easing the pressure on
the financial system and quelling fears about a credit crisis.”
As an investor, it’s important to remember that no one knows what the future holds or how central banks and markets will respond.
what’s the
difference between a bull and a bubble? During
2013, stock markets in the United States and Europe generally delivered very
attractive returns so it’s not all surprising that talk of market bubbles fills
the air. After all, bubbles are not a new phenomenon and they’ve done some
damage in the past.
In the 1800s
Charles Mackay penned Memoirs of
Extraordinary Popular Delusions and the Madness of Crowds. The book chronicled
some of the earliest bubbles, including Holland’s Tulipmania of 1624 during
which tulip bulbs were valued more highly than gold. He also describes the popularity
of the South Seas Corporation whose shares traded higher and higher (on little
more than word of mouth) until the stock crashed. More recently, we’ve
experienced bubbles in stock markets, real estate, technology stocks, and other
types of assets.
So, how do we
tell the difference between a bull market and a bubble? According to The Economist, Nobel Laureate Robert
Shiller of Yale University, “Describes a bubble as ‘a psycho-economic
phenomenon. It’s like a mental illness. It is marked by excessive enthusiasm,
participation of the news media, and feelings of regret among people who
weren’t in the bubble.’ They are often enlarged by an expansion of credit.”
Shiller measures
valuation levels using cyclically-adjusted price-to-earning ratios (CAPEs). According
to Barron’s, the Shiller CAPE for the
S&P 500 Index was at 21 in January of 2013. That was higher than its
long-term average and lower than its recent trend so U.S. equities were
somewhere between neutral and significantly over valued. Since January 2013,
some U.S. stock markets have delivered returns in the double digits, pushing
the Shiller CAPE toward 25. On the face of it, U.S. equities appear to be
highly valued.
However, in early
December, The Economist reported Shiller
was “not yet ready to declare a bubble in American equities… There is nothing
like the same excitement about shares that was seen in the late 1990s; net
flows into mutual funds only just turned positive this year. Another measure of
public indifference is CNBC, a television station that tracks the financial
markets, suffered its lowest ratings since 2005 in the third quarter.”
So, is this a
bubble or a bull market? The experts aren’t certain. Keep your eyes peeled for signs
of irrational exuberance.
Weekly Focus – Think
About It
Every day of the week, The Economist explains a new topic on
its website. The most popular explanations during 2013 included:
- What
is the difference between Sunni and Shia Muslims?
- How
does copyright work in space?
- Why
are your friends more popular than you?
- How
did Estonia become a leader in technology?
- Why
are there so many tunnels under London?
- Why
don't Americans ride trains?
- How
might your choice of browser affect your job prospects?
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