Are we in a bubble?  A few clients have asked this recently—a natural one with the major indexes reaching new highs.  The short answer: we’re probably not in a bubble, but cautious investors should consider reducing their equity bets.  The stock market is high because corporate profits are high, and stock prices ultimately are driven by earnings.  See chart here:  Chart

This week we review three articles addressing this question.  Liz Ann Sonders, Chief Investment Strategist of Charles Schwab & Co, says it is premature to be calling this market a bubble.  The second article, by Howard Marks of Oaktree Capital Management, says that riskier behavior is observed in the market, but he doesn’t think we have reached a danger zone yet.  Finally, Jeremy Grantham of GMO expects the U.S. stock market to rise another 20% to 30% in the next year or ‘more likely’ two.

Dismiss Bubble Talk…for Now.  It is premature to be calling this market a bubble, according to Liz Ann Sonders, Chief Investment Strategist at Charles Schwab & Co.  This market has little resemblance to past market tops. “I am by no means dismissing the possibility of a market correction, especially around the beginning of Fed tapering.  Historically, corrections associated with the beginning of a higher rate cycle have been generally in the 5-10% range; and it may not be that different this time round.  But a normal single-digit correction is something entirely different than the end of a bull market…markets are not yet trading near past valuation peaks.”

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Markets haven’t reached the danger zone yet.  Howard Marks of Oaktree Capital Management believes strongly that most of the key phenomena in the investment world are inherently cyclical.  “The cycles aren’t predictable as to timing or extent.  However, their fluctuations can be counted on to recur…the details don’t repeat but the rhyming patterns are extremely reliable…now we’re seeing another upswing in risky behavior…it has gathered steam…but not to anywhere near the same degree as in 2006-2007…I have no doubt that markets are riskier than at any other time since the depths of the crisis in late 2008 or early 2009, and they are becoming more so

[however] I don’t think it’s time to bail out of the markets.  Prices and valuation parameters are higher than they were a few years ago, and riskier behavior is observed.  But what matters is the degree, and I don’t think it has reached the danger zone yet.”

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The path of least resistance for the market will be up.  Jeremy Grantham is a Renaissance man in the investment world.  His quarterly newsletters are deep, thoughtful and far-ranging.  He gazes at the world with an eye firmly-centered on reality.

“I believe that it would take a severe economic shock to outweigh the Fed’s relentless pushing of the market….in equities there are few signs yet of a traditional bubble.”  He expects the U.S. stock market to rise another 20% to 30% in the next year or ‘more likely’ two—before the next mega-crash. He cautions:  “Investors should be aware that the U.S. market is already badly overpriced—indeed, we believe it is priced to deliver negative real returns over seven years…he suggests prudent investors should already be reducing their equity bets and their risk level in general, suggesting that prudent investors will have to endure the pain of foregoing all the fun at the top end of markets.”

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We hope you enjoy reading these articles along with us and that you find them informative.  Please forward this to your friends and family.

J. Mark Nickell & Co.


Disclosure – The articles mentioned in This Week with J. Mark Nickell & Co. are for information and educational purposes only. They represent a sample of the numerous articles that the firm reads each week to stay current on financial and economic topics. The articles are linked to websites separate from the J. Mark Nickell & Co. website. The opinions expressed in these articles are the opinions of the author and not J. Mark Nickell & Co. This is not an offer to buy or sell any security.  J. Mark Nickell & Co. is under no obligation to update any of the information in these articles. We cannot attest to the accuracy of the data in the articles.