A Nobel Prize-winning economist’s valuation tool has reached a level hit only in 1929 and the Tech Bubble. A freak computer-related event could rattle high-speed traders. Like headlines about Greece, those previous sentences could have hit the front page at any time during the past few years. Yet they are “breaking” news this week. Though the specific details vary, these are the latest iterations of long-existing false fears in this bull market—a sign euphoria isn’t here. Stocks still have a wall of worry to climb.
Since this bull market dawned, pundits have frequently recycled fears, repackaging and dressing them up to appear “new.” The specifics are slightly different, but the broad fear is the same. Consider the morphing fears surrounding debt. Folks widely feared 2009’s record deficits exceeding $1 trillion. Ditto in 2010. 2011’s debt ceiling fight, the loss of the US’ AAA-debt rating and muni-pocalypse fears followed. In 2012, student-loan debt fears perked. Then the debt ceiling returned![i] More recently, it’s fears the dollar will lose its status as the world’s primary reserve currency.
Consider, also, eurozone fear morph. Our tale starts with Greek debt, but it doesn’t end there.[ii] Portuguese debt. Irish banks. Italian debt. Spanish banks. Greek bailout negotiations. Greek default. Greek political turmoil. Greece going bankrupt. Greek default. Cyprus banks. Austerity driving recession. Deflation doom spiral. A eurozone version of Japan’s “lost decade”. Greek political turmoil. Greece going bankrupt. And don’t forget China slowdown fears! Its hard landing has allegedly been in the works for years now, with all sorts of catalysts to bring it about. A real estate bubble. Construction crash. Shadow banking. Local debt. Manufacturing slump. Property crash. All the while, the Middle Kingdom has continued growing at a steady, albeit slower, rate.
While the headlines are different, the content isn’t actually new. Handwringing over Tobin’s Q-Ratio—that fancy valuation metric hitting 1929 levels—is the latest morphing of overvalued-market fears. These concerns popped up way back in May 2009, when folks argued stocks were moving “too far, too fast” after hitting their highest price-to-earnings (P/E) ratio in seven months. “Overvalued” warnings and bubble claims were present in 2010. Today, warnings about an expensive market are rampant. The cyclically-adjusted price-to-earnings ratio (CAPE) is at its highest point since 2007—right before the 2008 financial crisis. The “Buffett Indicator,” which compares US market cap to gross national product, is at second-highest level in 50 years—the highest was in 2000.
As if on cue, the Q-Ratio is also at a level similar to a previous crisis.[iii] Developed by economist James Tobin, the Q-Ratio divides market cap by the “replacement cost” of all included companies—the amount of money each would have to spend to replace all physical and intangible assets. With a reading of 1.10, the ratio has doubled since 2009 and is approximately 65% above its average historical level of 0.68. But in our view, this latest valuation dread is just as faulty as its predecessors. Similar to trailing P/E ratios and the CAPE, the Q-Ratio works with backward-looking data[iv]—not helpful when forecasting forward-looking stocks. Investors heeding Q-Ratio levels as a sign of an expensive market assume stocks mean revert to some “average” level—a fallacy. By the Q-Ratio’s reckoning, stocks were overvalued in every year of this bull—yet it has charged on for over six years. Normal 12-month trailing or forward P/E ratios can provide a rough indication of sentiment, and they’re only slightly above their long-term average—mildly optimistic, not euphoric.
Similarly, the latest round of market-going-haywire fears—the “leap second”—is also not truly new news. It is a mashup of technical glitch and high-frequency trading (HFT) fears, near-constant since May 6, 2010, when the S&P 500 plunged as much as -8.6% in a 45-minute period now known as the “Flash Crash.” Though stocks recovered most of those losses by day’s end, pundits said the sharp market decline highlighted the market’s structural flaws and accused algorithmic High-Frequency Trading (HFT) as the main culprit. Five years on, and there isn’t much evidence HFT actually caused the flash crash,[v] but this hasn’t stopped the fears. Similar hiccups—like 2013’s “Tweet Crash” and October 15, 2014’s US Treasury yield gyration—amplified concerns. Technical glitches like the Nasdaq’s botching of Facebook’s IPO in 2012 and outages in 2013 reinforced fears of the market’s vulnerabilities to any tiny little thing that could go wrong.
Now we have the “leap second.” On June 30, standard time around the world will be adjusted by one second to make up for the slight difference between clocks and the earth’s rotation, an adjustment made once every few years. Now, past leap seconds were implemented without trouble, but some folks fret this time is different because, you know, HFT goes fast and can trade a lot in a second. They posit the update could throw off sophisticated trading algorithms, potentially causing computers to go haywire. Which seems overwrought and reminiscent of the Year 2000 Glitch, Y2K, which some market forecasters went so far as to dub, “The Millennium Bomb.” It was a dud, and the leap second is likely equally feckless. Even if there is a weird blip in markets because computers can’t handle an extra second everyone knows is coming (and one they have ably handled before), its impact is likely fleeting for long-term, growth-oriented investors. The only way to get hurt is to panic and sell at the bottom of the (possible) blip.[vi] Plus, this will happen right before 8pm Eastern time—unless you happen to be day-trading on Asian exchanges, it should have zero impact on your investment world.
These latest wrinkles are chapters in long-in-the-tooth fears morphing throughout this bull market. Are they getting as much hyperbolic play in the press now? No. But in our view, these stories are all evidence that while investor sentiment is becoming more optimistic, skepticism persists. The bricks in the wall of worry may be a different color, but there’s still wall left for stocks to climb.
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[ii] Actually it does, technically, because the merry-go-round has turned a few times.
[iii] In the Q-Ratio’s case, the 1929 peak and the 2000 Tech Bubble.
[iv] These data, released at a two-and-a-half month delay, are from the quarterly “Financial Accounts of the United States”—specifically, the cost-adjusted measure of Corporate America’s net worth
[vi] Easier said than done, but essential for investors—stocks are volatile, and volatility comes and goes without warning.