Is the stock market in a bubble?
The US stock market has been rising now for 5 ½ years. It’s hitting record levels. Mergers and acquisitions are taking off. The S&P 500 is up 190% from the bottom it recorded in March 2009. And a lot of folks are worried. Headlines tell investors to move to cash. Charts come out that compare the current market to 1987, warning people that a 30% correction could be in the works. What to do?
By some measures the market looks expensive. By some measures it looks fair. By others it looks cheap. Momentum players try ride the latest trend, but what starts with the heart often ends in tears. William Shakespeare saw this problem 500 years ago. He wrote about a pair of “star-crossed lovers” who saw what they wanted to see and disregarded the fundamental character of the world they lived in.
In Romeo and Juliet, the heroine reflects on the fact that her heart-throb is from the wrong side of town. “What’s in a name?” she asks. “That which we call a rose, by any other name would smell as sweet.” She only sees his virtues—not his rashness, not his reckless disregard for his or anyone’s safety, not his mindless devotion to his own passions.
Confirmation bias is a real problem for investors. Anticipate a crash and you quickly notice more and more evidence confirming your concern. Look for a rally to continue and soon everything supports that thesis. Seasoned investors look for data that contradicts—rather than confirms–their expectations. If Juliet had been a little less stubborn, she might thought twice about pretending to be dead—a pretense that ends badly for both her and her lover.
A market isn’t in a bubble because a few lines fit into a graph. Corrections come and go, but a market’s long-term performance is based on its fundamentals. Just because you believe something doesn’t make it so.
Douglas R. Tengdin, CFA
Chief Investment Officer