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Summary

  • We argue that the talk of a stock market bubble relies on too much focus from the depths of 2009 to today.
  • It is important to examine long time periods of over ten years.
  • When examining time periods of ten years or more, we find the US stock market has provided investors poor returns over the last ten years meaning no bubble.

Every day it seems as if there is at least one article arguing the US stock market is in a bubble or a large US stock market correction is near. Many of the writers who argue that there exists a stock market bubble typically cite the run up in stock prices from the low of 2009 to the stock prices today. If one invested in the S&P 500 at its low in 2009, their stock return today would be over 23% on an annual basis. That is a high return for any stock market index over a five-year period. The S&P 500 is close to tripling from the lows of 2009. If one is to view the large increase from that perspective, the only conclusion is to view the US stock market in a current bubble.

We argue that if you look at various time periods, the US stock market does not appear to be in a bubble and too much focus is present on the increase in stock prices from 2009 to 2014.

For example, let us assume one started to invest their money at the S&P 500 high in 2007. Now assume a major financial crisis was avoided so that the US stock prices did not plummet. Perhaps we had a typical correction and then continued to increase. Therefore, there was no high volatility experienced and no focus on the depths of 2009. If one held their money in the S&P 500 up until today, their annualized return from the high would have been close to 3%. That is a pretty low annual return for a seven year period.

In the scenario described above, the articles of today would be written on how the S&P 500 is producing low returns even at the S&P 500 level in the 1900 level range.

The point of the example is to explain that too much focus is put on the low of 2009 and the emotional memory of the 2008-2009 financial crisis.

Not let us assume an investor invested money in the S&P 500 at the high of 2000. The annualized return from then to date would be close to 1.7%. Again a very small return for a fourteen year period.

If an investor started to invest in August of 1997, their annualized return would be close to 4% over a seventeen year period.

The moral of the story is that the large S&P 500 swings up and down tend to create focus on those past swings. If one looks at longer time periods and ignores the large volatile swings, the picture looks very different. A 4% annual nominal return investing in US stocks over a seventeen year period is a low return given the risk.

If we look at another seventeen year period such as from 1983 to 2000, the annual return was over 16%. A seventeen year period of average annual returns greater than 16% is historically high. Based on that information alone I would consider that the US stock market was in a bubble during that time period. However, after experiencing two financial crises in 2000 and 2008 in addition to a tripling of the S&P 500 from its lows in 2009, the talk of a bubble is overdone.

Let us take a look at two figures. One figure displays the growth of $1 invested from 2000 to 2014 and the other displays the growth of $1 invested from 1986 to 2000. Both figures present a growth of $1 over a 14 year period therefore we use the same x-axis scale.

(click to enlarge)

(click to enlarge)

Now pretend as if the dates are not present. If someone presented both figures to you, which figure would you suggest that there was a bubble present? Obviously the 1986-2000 figure. We argue that one must examine long time periods to conclude that a bubble exists or not. If one is too look at long time periods it makes sense that the US stock market experienced two crises in one decade after the incredible stock market run from 1983 to 2000. The US stock market cannot go up in a straight line.

We conclude that the S&P 500 is not in bubble territory. We suggest that SPY may experience a pullback but not crash in the near future.

Source: Stock Market Bubble?