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Bay Area Research Rant: What’s so Attractive about Gloom?

By Garrick Brown, Vice President of Research – West Region

 

First off, I want you to check out this article that GlobeUmbrellaBusiness Insider ran yesterday, “Today’s Stock Market Bubble is Bigger than the Dot.Com Boom.”  I want you to check it out because this is such a great example of what to NOT listen to in the marketplace.  Now don’t get me wrong. I am not saying that there is no risk of a bubble nor am I saying that this current cycle couldn’t end with the bursting of a bubble. What I am saying (as I have been saying for the last two years as this topic has increasingly come up) is that we aren’t there yet and really aren’t even close to being there. But let me walk you through why you shouldn’t listen to drivel like this.

Let’s start by looking at the argument itself. In it, Harry S. Dent, Jr. argues that not only is the stock market is in the midst of a massive new bubble, but it is the worst kind… an artificial one!  What does he mean by that?  He means that current stock pricing hasn’t got anything to do with underlying fundamentals like “demographics, rising technology, and falling interest rates.”  He leaves out another fundamental that might be worth considering, which is the actual profitability of the companies being traded on Wall Street, but that is kind of a pretty big fundamental one might want to consider.  Regardless, he then proceeds to give a nice little Econ 101 breakdown of what  bubbles are and how they form and blah blah blah… for his first big piece of evidence he trots out a graph entitled “S&P 500 Bubble: Then and Now.”  And what does this graph show?  It just shows an overlay of prices going up over the periods of 1994 to 1999 and from 2010 to now.  Putting the two together, Dent argues, “Put the S&P 500 bubble from 15 to 20 years ago on top of today’s and what do you get? A damn bubble!”

His logic is simple. The S&P has climbed back above the 2,100 mark. There was a bubble back in 2000. When that last bubble burst S&P was at roughly 2,000 so that must mean we have another bubble.  He does the same thing with a NASDAQ chart and reverts to the same basic argument.  The entire basis of this “sky is falling” argument comes down to “the index was high before and it crashed. It is high again so it must mean it will crash again.”

There is only one thing missing from the argument though… and that is a discussion of the underlying fundamentals that he claims early in the article are completely missing.  Let me give you the most important fundamental that he chooses to ignore and that is profitability.

A real bubble burst in 2000 because investors bid up prices for dotcom and tech stocks to the point where they became disconnected from the underlying economic fundamentals. People paid way too much for stocks in companies that weren’t making any money.  It’s not rocket science; if you pay a lot of money for stock in a company that isn’t making any money… that’s BAD. But what if you are paying a lot of money for stock in a company that’s making a boatload of money?

This is why when it comes to the bubble question that the Price/Earnings (PE) ratio is so important. It puts into perspective those scary prices that Mr. Dent wants to frighten you with with what the companies are actually earning.  The S&P 500 P/E Ratio at the height of the bubble was 44.00. I believe it stood at 21.59 as of yesterday.  The all-time historic average is about 15.00.  What’s this tell us?  In terms of value, stocks may be trading a little high right now but we’re still at less than half of what we saw in the dotcom meltdown.

That gap gets even crazier with the more tech heavy NASDAQ index. As of yesterday the NASDAQ P/E ratio was 23.11 but it hit 194.00 as the bubble burst 15 years ago.  That’s right… that is how out of whack pricing was with earnings back then.  There is no doubt there are a few companies out there for which valuations don’t seem to make sense and there certainly are more than a handful of stocks that are trading at levels that are likely disconnected from the underlying fundamentals of their respective companies.  But on the whole, the market has not gone off the deep end. While it might make you nervous that the S&P Index has climbed over that 2,100 mark, it’s done so this time on the backs of profitable companies and not mere speculation.  But until we see the end of this cycle, we are going to be stuck with articles like these. Why? Because they sell books! Check out Harry Dent on Wikipedia. He’s the author of The Great Depression Ahead (2009), The Great Crash Ahead (2011) and The Demographic Cliff: How to Survive and Prosper During the Great Deflation of 2014 – 2019 (2014), among other titles. Picking up on a theme here?

There is a reason why every few years some death cult pops up somewhere.  There is a reason why that smelly guy with the bullhorn and “End is Near” sign at the Powell & Market cable car stop actually sometimes gets an audience going.  And there is a reason why apocalyptic economists usually sell more books than mainstream ones.  The fact is that we like certainty, even if it is in the form of doom. But that still doesn’t make it accurate.

 

This post is commentary from the latest weekly edition of our Bay Area Research Rant, which you can subscribe to for free by e-mailing garrick.brown@dtz.com

 

BrownGarrick joined DTZ (Cassidy Turley) in October 2010. He serves as Vice President, Research in the Western US for DTZ as well as our retail division in Northern California, DTZ Retail – Terranomics. He speaks frequently at industry events and has been a keynote speaker at symposiums, conferences and market forecasting events for groups like the Appraisal Institute, Urban Land Institute, CREW, ICSC and PRSM. He is also a member of Lambda Alpha International, an invitation-only land use society for those who are involved in the ownership, management, regulation and conservation of land, but also those who are involved in its development, redevelopment and preservation.

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