Market Commentary: The Case Against a Stock Market Bubble

“Please, God, just one more bubble.” — Popular Silicon Valley bumper sticker after the tech bubble burst  

With stocks near all-time highs, many believe they must be in a bubble. Take note, many of these bubble callers are the same bears that fought this bull market all the way up. Now they are taking a different angle on their incorrect calls and blaming a bubble for the stock market’s strength. It can’t be that they were wrong on fundamentals; it has to be that markets are acting irrationally. 

We disagree, as this is not a bubble. Do some elements of the market feel over the top? Sure. Excitement over the Magnificent Seven tech-oriented companies at the start of this year showed some bubble-like characteristics. And sure enough, both Apple and Tesla have drastically underperformed lately. But a bubble overall? No way.  

Let’s start at the beginning. What is a bubble? We like this definition from Forbes: 

A stock market bubble — also known as an asset bubble or a speculative bubble — is when prices for a stock or an asset rise exponentially over a period of time, well in excess of its intrinsic value. Eventually, prices hit a wall and then fall very far, very fast, as the bubble “pops.” Bubbles can occur to all kinds of assets in addition to stocks, from real estate and collectibles, to commodities and cryptocurrencies. 

Famous bubbles include the tulip market in Holland in the 1600s, the South Sea bubble in London in 1720, railway bubbles of the 1840s, the roaring ‘20s (followed by the crash of 1929), the Japanese real estate and stock market bubble of the 1980s, the U.S. tech bubble of the 1990s, and the housing bubble earlier this decade. Many other bubbles of excitement have taken place, including for things like baseball cards, beanie babies, and even Wordle if you ask me. Bubbles can refer to anything that is popular and sees tons of excitement but crashes when the hype proves too much.  

In some cases, prices drop more than 90% when bubbles pop, and they rarely recover. If they do, the recovery can take decades. It took Japan’s Nikkei 40 years to return to new highs, while many tech bubble stocks will never recover their losses. 

Is the Magnificent Seven a bubble? Many smart people are saying this, but let’s not forget that these companies are making a lot of money. How many companies in the late 1990s soared simply because they added “dot com” to their names? Trust me, there were many. More recently, the meme stock craze of 2021 stands out as a bubble. Many of those stocks had very little value, poor earnings potential, and headwinds to growth; yet, traders pushed them up to astronomical levels. Many came all the way back to earth. Here’s AMC for a perfect example.  

What goes up chart

Amazon now sends customers medicine, and Apple is practically a bank with Apple Pay. In the past, a railroad stock was just a railroad stock, but that isn’t the case anymore with these large companies. Below is chart of how much these companies are making — it’s a lot of money. 

The Mag 7 Makes a LOT of Money chart

Below are price-to-earnings (p/e) ratios on the Magnificent Seven. I’m old enough to remember the late 1990s and how p/e ratios in the 100s were normal, at least until they weren’t. P/e ratios in the 30s, 40s, and 50s are indeed pricey, but a bubble is an overstatement. 

The Mag 7 Is Pricey chart

Is the stock market in a bubble overall? Some pockets are quite pricey, but we don’t think so. Small-caps aren’t even at all-time highs, and they are historically cheap relative to large-caps. The Nasdaq has been practically flat since November 2021. That doesn’t exactly scream stocks have gone too far, does it?  

We’ve been overweight equities since December 2021, and we’re comfortable staying there. One main reason is strong earnings. In fact, forward 12-month S&P 500 earnings hit another record recently. Incredibly, earnings estimates have jumped 2% over the last six weeks. While stocks have soared during that same period, improving earnings helps to justify their rise.  

Forward earnings expectations still marching higher chart

The trailing 12-month p/e ratio for the S&P 500 is about 26 versus the five-year average of 23 and the 10-year average of 21. Stocks are a bit pricey, but by no means are they historically out of line. If tech is removed from the equation, those numbers are estimated to drop approximately three points, putting stocks right in line with historical averages.  

S&P 500 trailing 12-month p/e ratio: 10 years chart

One reason many claim the stock market is in a bubble is 2023 earnings were barely positive while stocks soared, implying it was all multiple expansion. As Lee Corso would say, “Not so fast, my friends.” 

From the end of 2019 through March 15, 2024, the S&P 500 has gained 71%. Not bad given two bear markets took place over that period. But where did those 71 points come from? Returns can be generated from three places: earnings growth, multiple growth, and dividends.  

We found the 71% gain was divided as such: 

  • 47% earnings growth 
  • 15% multiple expansion 
  • 9% dividends 

 In other words, that bubble came from mainly earnings and dividends. Not quite the story that loud guy on X told you, huh? 

Returns mostly driven by earnings over long periods chart

Contrary to all the bubble talk, two recent studies suggest the continued path for stocks is indeed higher. Over the past 20 weeks through March 15, the S&P 500 has risen 24%, which is one of the best 20-week rallies in history. We found 22 other times stocks gained more than 20% in 20 weeks, and one year later stocks were still higher 21 times. In other words, strength off the late October lows is consistent with the beginning of longer-term market strength, not the end of a bull market.  

The Run Since the October Lows Could Still Have Room to Go chart

Lastly, it has been a great start to 2024, with the S&P 500 up 8.3% as of the 50th trading day of the year, which was a week ago Wednesday. We found 25 other times stocks were up at least 5% on day 50, and the rest of the year was up an incredible 24 times for 12.6% on average, compared to the average return of 7.6% for the rest of a typical year. 

A Good First 50 Days Could Mean a Great Rest of the Year chart

A Dovish Fed Signals Rate Cuts Amid a Strong Economy — That’s Bullish 

The Federal Reserve left rates unchanged at its March meeting, but the headline takeaway was that the median official continues to project three interest rate cuts in 2024, each worth 0.25%. Going into this meeting, a big question was whether Fed members would lower that projection to just two cuts in their summary of economic projections (the dot plot). Keep in mind that even two cuts for an economy that’s running strong is a welcome tailwind for growth. But there was concern that Fed members would signal a big shift in their thinking, spooked by two months of relatively hot inflation data. However, Fed Chair Jerome Powell pointed out that they’re not “overreacting” to recent data, just as they didn’t overreact to the soft inflation data over the prior six months. He stressed that the overall narrative remains the same: Inflation is trending down along a bumpy path.  

Bullish on the Economy, But Not Worried About Inflation 

The details within the Fed’s dot plot were even more bullish. Fed officials upgraded their economic growth projections for 2024 from 1.4% to 2.1% (real GDP growth). That’s a big jump and acknowledgement that the economy is strong. Their nominal GDP growth forecast for 2024 (real GDP growth plus inflation) increased from 3.8% to 4.5%. Nominal GDP growth is where company profits come from, and by itself that’s positive as far as markets are concerned.  

Fed Officials Upgrade GDP Growth Projections, Big Time chart

Even more interesting: Fed members increased their core inflation (core PCE) forecast for 2024 from 2.4% to 2.6%.  

All this to say, the Fed’s still projecting three cuts in 2024 — taking the federal funds rate down from 5.4% to 4.6% by the end of the year — even as Fed members upgraded their view on the economy and projected core inflation to remain above their target of 2%. It’s one thing to project rate cuts in the face of a slowing economy and lower inflation. But they did the opposite, and that’s a big deal. 

Fed members still project 3 cuts in 2024, despite projecting higher core inflation

Interest Rate Cuts Will Be a Tailwind for the Economy 

Powell did say the projected interest rate of 4.6% at the end of 2024 would be higher than the Fed’s long-run estimate of the “neutral rate” of 2.6%, implying that monetary policy will remain restrictive. However, the economy managed to avoid a recession in 2022-2023 despite rates at 5.4%. Even better, the economy grew 3.1% in 2023 (inflation-adjusted), well above the 2010-2019 trend of 2.4%.   

The labor market has been the backbone of the economy, with rising employment and strong wage growth coupled with easing inflation boosting consumption. Another positive from the Fed meeting is that Powell said Fed members are aware of the risks of not doing enough, i.e., cutting rates too little and too late and causing “unnecessary harm” to the labor market. They clearly want to hold on to the strong employment gains that have occurred over the last two years. Up until last year, the Fed was willing to risk higher unemployment if that’s what it took to quell inflation. That’s no longer the case. With inflation heading the right way (down), the Fed likely has the back of the labor market once again.   

At the same time, interest-rate sensitive areas of the economy, notably housing and equipment investing, have been a drag on growth since 2022. This is evident in the chart below, which shows the main components of our proprietary leading economic indicator (LEI) for the U.S. Consumption more than offset the drag from other areas of the economy and kept the economy humming. There’s reason for optimism as former headwinds turn into tailwinds. Investors, consumers, and businesses sense that interest rates have likely peaked this cycle and cuts are coming. Or LEI indicates the economy continues to grow along trend, if not slightly above it (zero implies trend growth in the chart below). 

Economy Getting a Boost from Cyclical Areas chart

Take housing as an example. Single-family housing activity makes up the bulk of residential investment within GDP, and that crashed in 2022 as the Fed raised rates. Housing dragged on GDP growth for nine straight quarters (through the second quarter of 2023). That shouldn’t be a surprise because housing is perhaps the most interest-rate sensitive sector of the economy, and mortgage rates surged from around 4% to 8%. The good news is single-family activity has been trending higher since late last year, as rates pull back in anticipation of rate cuts by the Fed. As of February, starts are up 35% from the prior year and are now 27% above the 2019 average. Permits, which are a sign of future supply, are up 30% year-over-year and 19% higher than the 2019 average. In short, housing is likely to add to GDP growth this year.  

Single-Family Housing Activity in Strong Uptrend chart

Similarly, a pullback in rates will likely boost the manufacturing sector, as businesses start to invest more in equipment and machinery. Parts of the manufacturing sector, especially defense and hi-tech equipment, are already running strong. But it will be positive to see broader strength. 

Ultimately, what matters for stocks is profits. And if the economy is strong, profits will continue to grow. The icing on the cake is potential rate cuts could boost the most cyclical areas of the economy. 



This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.

S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly-traded companies from most sectors in the global economy, the major exception being financial services.

A diversified portfolio does not assure a profit or protect against loss in a declining market.

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