the audit

Bubbles, bubbles everywhere

Stocks, like housing, are not detached from realistic prices
August 27, 2013

Press hysteria about another housing bubble seems to have cooled off a bit in the last few months. Which is good, since we’re not in another housing bubble.

But once you become convinced that we’re in a bubble, you start seeing them everywhere. Take this post by Gawker’s Hamilton Nolan headlined “Bubble Watch: Ridiculous Stock Values Edition.”

Which ridiculous stock values? Nolan quotes a Bloomberg report on growing earnings multiples:

The benchmark gauge for U.S. equities has risen 14 percent relative to income over the past 12 months to 16 times earnings, according to data compiled by Bloomberg. Valuations last climbed this fast in the final year of the 1990s technology bubble, just before the index began a 49 percent tumble. The rally that started in March 2009 has now outlasted the average gain since 1946, the data show.

And adds this:

A replay of the year just before the collapse of the tech bubble, and a rally that is, historically speaking, ripe for its end. What could go wrong?

Sign up for CJR's daily email

Now, it’s somewhat interesting that P/E ratios have risen so fast. But the pace of an increase in average P/E doesn’t in and of itself tell us much of anything about a bubble. For that, you have to look at the P/E multiple itself.

And it’s at 16 times earnings, which is hardly hair-raising. That’s right at its historical average through bull runs and busts.

It’s still well below the average P/E ratio for bull markets, as Bloomberg points out in the very same story:

The average multiple during bull runs since 1957 has been 17.4 times reported profits, about 10 percent higher than today’s ratio, data compiled by Bloomberg show. Advances ended at 20.2 times earnings on average, 26 percent higher than the present level.

Price increases—even large, rapid ones—don’t necessarily mean something is a bubble. They have to be accompanied by investor expectations that have become detached from fundamentals.

That’s not the case here (at least for the S&P as a whole). Stocks are up a bunch in the last few years, but so are profits. And the increase in stock valuations in the last year could be happening for a number of reasons. The big one is probably the coming unwinding of the Fed’s quantitative easing program, which has made bonds less attractive. But it could also be that investors are betting that future profits will grow stronger increase as the economy continues to recover.

Not every bull market is a bubble. In fact, most aren’t.

Further reading:

No, it’s not another housing bubble. Hysteria in pockets of the press over a long-awaited recovery

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR’s business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.