If This Really <i> Is</i> a Bubble, How Long Before It Bursts?
Two things about market bubbles: First, it’s often hard for investors to admit when they’re in one. Second, when guessing how big a bubble can get, it’s often wise to err on the high side.
With the Dow Jones industrial average already up 30% this year, 89% since 1990 and now just 31 points from the 5,000 mark, stocks’ incredible resilience astounds even some of the most ardent bulls.
As for the bears--well, nobody likes to be played for a fool, and anyone betting against U.S. stocks in the 1990s feels foolish no matter how else they try to couch their reluctance to join the game.
How to explain a market that just won’t quit, regardless of what threatens it--a sluggish economy, slowing corporate earnings growth, Mexico’s peso crisis, the federal government’s shutdown, etc.?
One explanation emanating from both Wall Street camps, bull and bear, is that this market surge is a classic bubble, an inflation of prices that pushes aside obstacles, and reason, as it expands. What distinguishes the camps is their estimation of where we are in the bubble stage: early, middle or late.
Glen King Parker, publisher of the Market Logic newsletter in Deerfield Beach, Fla., and an immovable bear, insists that at Dow-5,000, stock prices are “way out of line with reality,” no matter which particular reality you want to use: interest rates, corporate earnings, dividends or inflation, among other yardsticks.
“I think we’re well advanced into the bubble stage already,” Parker says. Too many investors, he says, believe that this is a “new era,” a period when old rules don’t apply to stocks and when the only possible direction for the market is up.
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The Japanese, Parker notes, felt the same about their stock market in the 1980s. Now, six years into Japan’s devastating bear market, investors there understand why “it has always paid to bet against new eras,” Parker says.
But hold on a minute. Japan’s market was a textbook case of a bubble that burst. But before it exploded, it grew to Gargantuan proportions. The Nikkei 225-stock index rose at a double-digit pace every year between 1983 and 1989, rocketing 386% from 8,017 to nearly 39,000 at its peak.
A permanent new era for Japanese stocks it wasn’t, but as even Parker concedes, “it looked that way for a long time in the ‘80s.”
If the U.S. market is also a bubble, and 1995 is our equivalent of 1989 in Japan, the end is near. But what if, figuratively speaking, it’s only 1986 on the Japanese bubble scale? Or even 1988? Then there’s a lot of maniacal behavior left in this mania, and a lot of money yet to be made in U.S. stocks.
Are the comparisons with Japan even fair? There are plenty of similarities between Japan then and America now: They were considered the world’s most competitive economy in the late 1980s; that’s America today. Their government was exceedingly pro-business then; ours is trying to be today. And their stock market run-up was mostly the work of Japanese investors, just as Wall Street’s advance is powered largely by Americans, with many foreign investors still suspicious of U.S. equities.
Perhaps most important, Japan’s central bank maintained low interest rates through the late 1980s, stoking the market’s fires. The U.S. Federal Reserve Board, poised to cut rates again before year’s end, is pumping the same powerful bellows.
There also are many differences, of course. Japan’s stock market bubble was fed in part by a massive real estate bubble; ours is not. And Japanese stocks’ price-to-earnings (P-E) ratios at their bubble’s peak were in the stratospheric range of 70 to 100. The average U.S. blue-chip stock, in contrast, today is priced at 15 to 16 times estimated 1996 earnings per share.
For Wall Street’s bulls, that arguably still-reasonable valuation on U.S. stocks simply makes the case that if this is a bubble, at worst it’s in the middle stage of its inflation, certainly not in the final stage. Give the market more of what it wants--lower rates, moderate economic growth, a preeminent competitive position for U.S. industry, and a balanced federal budget--and investors can’t help but bid stocks higher, the bulls say. U.S. blue-chip stocks’ average P-E ratios may never reach 70, but what if they just go to 25?
“If a year from now the Dow is at 7,000, then we might be able to talk” about a bursting bubble, says Stamford, Conn.-based investment strategist Suresh Bhirud, a longtime bull. For now, he says, investors ought to just hang on and and enjoy the ride.
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Mania: Before and After
The only mistake you could have made with Japanese stocks in the 1980s was to underestimate how high they would go. Nikkei-225 stock index, yearly closes and latest:
Thurs: 17,939.52
Source: Bloomberg Business News
