The most frequently asked question right now is, “Are we in a bubble?” The simple answer is, “I can’t tell.” It’s an entirely natural question and answers will vary based upon the strategy and motivations of the person you’re asking. [i]
Here is what we know: Valuations are stretched across a variety of metrics. Extended valuations are likely the primary driver of the broad-based inquiry about being in a bubble. Even if you dissect the S&P 500 and removed the top 10 stocks (companies like Facebook, Google, Netflix), forward PE’s are still extended by 120% to 132%. [i]
There are a lot of ways to normalize valuations this year. One is to see the S&P 500 drop by 23.9%.
Another is to see corporate profits grow by 31.4%, holding the price of the S&P 500 at its current level.
The other method might be to look at what historical returns on the S&P 500 are when we start the year with elevated valuations. [ii]
If we have a 4.6% return on the S&P 500 and corporate earnings per share grow by 31.3%, we could see valuations return to normal over the course of this year. Note, the S&P 500 is currently up 4.7% year-to-date.
While it might feel a bit euphoric, it’s incredibly hard to predict if we are in a bubble; and, if we are, when will it pop and by how much. Bubbles are highly emotional, generally driven by a disregard for earnings growth and valuations. [iii]
Certainly, when you hear speculators bid up GameStop, Dogecoin, and other similar assets devoid of any form of positive earnings; it’s easy to think we are in a bubble. These “bets” are in the greed/ delusional spectrum.
If you combine the top five cryptocurrencies and throw in GameStop, Silver, and AMC Theaters that have all been bid up by greedy speculators, you get a combined market cap of $1.187 trillion. [iv] [v]
The delusion of a few is not the delusion of all. There are a lot of buyers of these speculative assets. According to a recent Harris poll, over 28% of Americans bought some of these uber-speculative assets. Here’s what the poll determined: [vi]
You have to dig deep into the survey to learn that the median (midpoint) purchase price for GameStop stock was in the $150 range. Link to full survey
That’s not to say we won’t have a potential shock along the way to normalized values. Just realize when we’ve had sudden shocks, the recoveries have been very strong and fairly quick. [i]
There are a lot of people doing silly things in small dollar quantities. Don’t be fooled by the headlines. The reason we might not be in a bubble is because of your Frequently Asked Question (FAQ) – “Are we in a bubble?” That question suggests there is still reasonable caution, heightened awareness of your last experience with euphoria around the Great Financial Crisis, and elevated precautionary savings.
“Are we in a bubble?” Who really knows, but as long as you have a longer holding period for your allocation, you’re likely going to be able to withstand the drawdown. Keep asking the question, it’s reassuring in itself.
Tim Phillips, CEO, Phillips & Company