A number of events and recently released economic data further boosted investor confidence last week leading to continued buying up of equities to record highs, which makes some wonder whether we are in a stock market bubble. The current environment while marked by a few global concerns is unlikely to be a bubble and stock market valuations in the US appear largely fair. In my humble opinion, US equities would likely enjoy continued, but moderate growth throughout the year.
This is what we saw in the news last week:
- Europe had mixed results with Germany leading the pack as expected. The eurozone economy grew 0.3% between the third and fourth quarters of 2014. Germany’s stronger-than-expected 0.7% pace. Germany hit all-time record highs for its trade surplus, exports and imports in 2014. With two-thirds of its exports going outside the currency bloc, the eurozone’s largest economy especially benefited from the falling value of the euro. Low oil prices and low inflation boosted domestic demand, leading to a rise in imports. Good news in Germany were partly offset by Italy’s 14th straight quarter without growth in output. For 2014, German economic growth was 1.6% while France expanded by just 0.4%.
- Greece remains the major concern of the eurozone. Its economy contracted by 0.2 percent yet investors reacted positively. Finally, investors were encouraged by cautious optimism that the European Union has a chance to reach a debt deal with Greece.The Eurogroup of finance ministers met in Brussels on Feb 16th to try to find common ground with Greece’ new government, in talks that could procrastinate for sometime. Government officials from Greece said on Sunday, February 15th that the Greek government was confident of reaching agreement in negotiations with the ECB. However, Greece’s commitment remains limited as sentiments among Greek political and economic leaders remains against harsh austerity strings in any debt pact. Investors have generally assumed a compromise would eventually be found about the situation in Greece, given the alternative might be a disastrous Greek exit from the euro.
- Oil Prices extended their still modest re-bounded as Brent topped $62 a barrel. While oil prices continue to be discounted compared to their high of over $100 a barrel, a modest recovering was supported by signs that deeper industry spending cuts may curb excess supply. Brent crude rose 42 cents to $61.94 per barrel, while U.S. crude added 34 cents to $53.12 per barrel.
- There was room for moderate optimism in Asia as well. Recently released economic data from Japan showed the Japanese economy emerged from recession in the final quarter of in 2014, though growth of 0.6 percent was short of market forecasts. China’s inflation rate fell to 0.8% in January from a year earlier — its weakest results since November 2009 based on falling commodity prices and tempering real estate valuations.
As a result, just in time for Valentines, the US stock market responded favorablly to global news: The S&P 500 ended at a record high and the Nasdaq hit a 15-year high. The S&P 500 added 0.41 percent, the Dow gained 0.26 percent and the Nasdaq 0.75 percent.
Source: Yahoo Finance S&P and NASDQ 10 year chart
As holidays momentarily paused trading in the US for Presidents Day and much of Asia is celebrating the Lunar New Year and China’s markets are off from Feb. 18 right through to the 24th, investors have time to ponder if the stock market in the US and worldwide has entered another over-priced bubble or economic fundamentals are strong enough supporting current equity valuations.
It is true that stock valuations have increased dramatically propelled by easy monetary policies especially in the US. However, there is enough economic fundamentals in the US to support continued, abate more modest gains this year. Below are some of the factors which make me moderately optimistic about the US economy and stock market valuations in the near future:
- US GDP continues to show economic strength. The US economy continued to post consistent GDP growth since 2010.
Source: http://ieconomics.com US GDP Last 5 Years
While we are not seeing GDP growth of the levels we saw in the 90s, the recovery post 2008 is evident:
Source: ieconomics – US GDP Long Term
- US unemployment rate has fallen steadily. The unemployment rate is at5.7 percent — the lowest since September 2008. And while bubble believers like to claim this is just from people leaving the labor force discouraged from the fact that they cannot find jobs,the Wall Street Journal wrote that as per Fed data, new jobs among the long-term unemployed accounted for 88% of the drop in the unemployment rate in 2014.
- US Stock Market Valuations are Reasonable and May Have More Room for Growth: Those that are afraid of a bubble are concerned that stocks have become overvalued. There are different ways to measure whether stocks are fairly valued or not. Let’s look at a couple measures:
- The forward price-to-earnings ratio of the S&P 500 is about 22.4 — high relative to the past few years and with select periods in history, but below the 20-year average. This is not to say stocks are a bargain; it’s just that valuations are fair. And a fairly valued market is by no means a sign of an equity bubble.
- Additionally, S&P price to earning ratio continues to be supported by strong corporate earnings. With low interest rates, affordable labour, and low oil prices it is likly that corporate earnings would continue to prosper.
Source: MLTP S&P Earnings Growth
- The Fed is Tightening at the Right Time and Gradually: Overall the US Fed has done a brilliant job navigating the US economy out of the 2008 mortgage debacle by implementing aggressive and timely monetary easing. Seeing the US economy strengthen, the Fed is naturally tapering its bond buying and may even begin to raise interest rates. However, rising rates are not necessarily bad for stocks. Since 1960, almost every period of rising rates has been accompanied by rising stocks. The reasoning is straight forward: The Federal Reserve loosens policy when times are bad, and tightens when the growth outlook is good. We are at the beginning of gradual and slow tightening. The US economy is growing while inflation is below 2% and hasn’t been above 3% since late 2011.
Alan Greenspan famously invented the term “irrational exuberance” in reference to the dot-com bubble in 1996, and his words have been synonymous with investor fears of bubbles ever since. However, there is no evidence of irrational exuberance and the stock market is hardly in the type of bubble we saw in 1996 or 2008. Instead market valuations are supported by gradually and steadily improving economic data in the US and careful, well managed Fed policy. As long as we see no surprises from global markets or no political instability flaring up in the troubles regions of the world (think Ukraine), than investors have little reason to worry at this point about the US stock market crumbling.