What a Real Bubble Looks Like

Headlines are back on bubble watch, and they're as hysterical as ever: "We're in the Third Biggest Stock Bubble in US History." "Yes, This Is a Bubble (and It May Be Worse Than 1929)." "Say Hello to US Economy's Newest Bubble" (the stock market). With the S&P 500 nearing 2000 and P/Es rising, it might seem like the bubble-bears are right. Yet rising prices alone don't make a bubble-true bubbles happen when sentiment is off-the-charts euphoric. When folks rationalize higher prices by saying reality has changed-it's different this time, so it's ok. We don't see this today. Stocks are in a big bull market, and in our view, there is nothing bubbly about it.

In a real bubble, charts won't compare today to 1929. Pundits won't complain a near-average (or below) P/E is too high. Or worry a rate hike will knock stocks. Instead, pundits will say "it's different this time" to explain why high P/Es are a-ok. They'll say risk is over. We're in a new age where things are only ever good, they'll claim.

This probably sounds weird-how could today's negative media turn so sunny? But we've seen it before. In early 2000, this euphoria-irrational exuberance, if you will-was everywhere. Here are some examples, courtesy of The New York Times' archive. These types of articles were everywhere, but the Times has the most robust, easily searchable archive of all the major publications, so we took advantage.

"Next New Era: The New Economy's Currency Is Stock, Stock and Stock"
The New York Times, 03/29/2000 (five days after the peak)

A Bay Area urologist treating a patient who works at an Internet start-up recently had an idea. For their next appointment, the urologist joked, he wanted to be paid in shares.

''Think of what the guy does all day, for a doctor's salary,'' the Internet executive said sympathetically. ''Of course he wants to get into the game.''

Like the bankers, lawyers and venture capitalists he reads about in the papers daily, the urologist wanted in on the action, and these days it seems that everyone but the doctor is welcome.

Today, hordes of business-to-business contractors who make deals with high-technology companies are trading their services for equity. While law firms have long taken slices of their clients' companies on top of regular fees, consultants are now doing the same, along with public relations agencies, executive search firms and commercial landlords. Even independent engineers and building contractors are participating in the equity swap meet. ...

"In Stock Market, a Revolutionary Shift on Risk"
The New York Times, 01/05/2000 (two and a half months before the bubble burst)

Since 1872, the market's price-to-earnings, or P/E, ratio - the number of dollars it takes an investor to buy a dollar's worth of a company's annual profit - has averaged about 15, and there was a clear pattern of P/Es' falling back to the averages if they strayed too high.

But during the last decade, P/Es have stayed consistently above 20 and lately above 30 - and stocks have kept rising. ...

We accept the notion of change in medicine, in physics, in psychology, even in the law. But in finance, the eternal verities are supposed to hold. Most of the time they do, and it is good to be skeptical. But sometimes, things really do change. We are in the midst of such a change today, and it is affecting not merely the markets themselves but also politics, culture and society. ...

My strong belief is that the rise in stock prices will continue at close to the same pace of the last five years. In that case, the Dow should hit 36,000 by 2005.

"Stock Indexes Paint an Imperfect Market Picture"
The New York Times, 04/23/2000 (one month after the peak)

From the day the Nasdaq composite hit a record high on March 10, through its trough on April 14, the index lost 34 percent of its value. Yet over that same period, the average United States stock actually fell by less than 1 percent.

That's right. By simply using a somewhat different methodology, it is perfectly reasonable to argue that not only are stocks avoiding the clutches of a bear market - traditionally viewed as a decline of 20 percent or more from a high - but that they also have a long way to go before even entering a correction - usually defined as a sell-off of 10 percent or more. ...

"A Slower Economy, but Still a Strong One"
The New York Times, 01/23/2000 (about two and a half months before the yield curve inverted)

The economy is so strong that even a sharp rise in interest rates this year is unlikely to stop growth in its tracks or hit individuals too hard.

Employers are likely to continue creating new jobs, albeit at a slower pace. The unemployment rate would probably creep up, but remain at a relatively low level. Incomes would continue rising, but perhaps more modestly.

There is a case to be made that rate increases by the central bank do not filter through the economy with the force they once did. But Americans would feel the effects nonetheless, though the full impact would not become apparent until 2001. Still, even if the Fed raises rates by more than many expect - say, a full percentage point this year - the results would not be cataclysmic by any measure. ...

Again, this is a limited sample-multiply it by a few hundred, and that's what the financial press looked like in 2000.

Now, ask yourself. Do you know a banker, doctor or lawyer asking for fees in stock instead of cash? Do all the pundits say high stock prices are fine because the world has changed? Do they try to minimize stock declines? Does everyone think the US can take a big rate hike, without even considering what it might do to the yield curve?

Nope. Today, we get the opposite. No mass hysteria, no euphoria. Just some scattered optimism, most of which is pretty rational. That's very strong evidence we're still smack in a big bull market that has plenty of room to run.