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Summary

  • Analysts talk about "bubbles" without defining what the term means. This makes their analysis worthless.
  • I provide a plausible, workable definition of a Bubble.
  • Using this definition, I use four Dow stocks to counter the idea the Dow Industrials are in a bubble.

Everyone enjoys a bull market, but my fellow optimists and contrarians enjoy it even more knowing that almost every single rally in the Dow over the last five years has been accompanied by analysts chirping about stocks being in a "bubble." Bubble chatter has always been a reliable indicator that this most hated of bull markets is about to enter a dynamic new phase.

What is most amusing is the "bubbleeers" never even define what they mean by a bubble to begin with. In this article yesterday I make clear this completely destroys any analysis and conclusions these authors might state. Yet the process never stops. Only a day ago Peter Schiff said recent price action suggests the stock market you-know-what might be deflating. Bubbles are everywhere: here; here and here.

Lest you simply suggest that a bubble is when prices reach record highs---BZZZT!!---you are wrong. Didn't you know we are in a bubble in bonds? Even though the US Treasury 20-year bond portfolio (NYSEARCA:TLT) is down 15% from its highs two years ago? If $115 is a bubble, I am afraid to ask what $134 was in 2012.

source: bigcharts.com

Since they won't define a bubble, guess what (drum roll, please). I will.

  • a stock market bubble occurs when shares suddenly rise to valuation measures (PE, P/Cashflow, etc) that are conspicuously higher than traditional, and historical, norms.

For example in 2000 companies like GE boasted p/e ratios in the fifties; and internet stocks boasted p/e's in the hundreds---if they even had earnings.

Here is a clever way to see if we are in a bubble. Let's look at the stocks in the Dow Jones Industrial Average that have reached new highs in 2014. A look at Stockcharts.com "Dow Stock Summary" shows seven companies have forged ahead in the last 5 months. If these highfalutin' high fliers aren't pushing record valuations, it is hard to believe the market as a whole is in a bubble.

After paring out cyclicals (which turn valuation upside down since the best time to buy them is when earnings are depressed) we are left with four companies: Disney (NYSE:DIS), Intel (NASDAQ:INTC), Johnson and Johnson (NYSE:JNJ), and 3M Company (NYSE:MMM).

On a price/earnings ratio basis, none of these stocks boast PEs that are anywhere near the levels they reached early in the previous decade as the market recovered from the 2000 debacle.

Look at Disney. Ten years ago the stock commanded multiples in the high twenties. It is hard to believe the current 21 is that lofty. A case can be made for some correction, but by no means have these levels signaled a bear market.

source: bigcharts.com

A glance at Valueline shows that the stock commanded a cash flow multiple over 20x in 2003; the current multiple of 14 seems quite reasonable.

The story is much the same for the other shares: I will just use PE since the song remains the same: if highfliers are not anywhere near record valuations, how can we say there is a bubble?

Look at INTC: The company's PE has been down so long the firm seems to be in a black hole, not a bubble:

Johnson and Johnson, a long-term dividend champion? The breakout a few quarters ago isn't a bubble: investors have finally cottoned to one of the market's most consistent performers. Folks who said there was a bubble last summer are, well, taking a bubble bath.

And what of America's science company, 3M? Folks who said there was a bubble when it skyrocketed to new highs this past January might want to, er, Scotch Tape this chart to their wall. (But not on Facebook!)

Again maybe there is a plausible case for a modest correction in the valuation applied to some of these stocks. But that isn't the bubblicious argument. Their argument is a big bad bear market is coming when the bubble bursts.

What Bubble?

Use careful, rigorous definitions of stock market and financial terms to sharpen your analysis and improve your portfolio performance. In this case it may prevent you from selling too soon.

Source: 4 Dow Stocks That Puncture The 'Bubble' Case

Additional disclosure: I am also short GLD