US Stocks Are Not In A Bubble… Yet (Transcript)
By datatrekresearch in Blog
DataTrek co-founder Nick Colas shares why we don’t think US equities are in a bubble, and the 3 signs that can help spot one in the latest video on our YouTube channel. He also explains how a stock bubble could develop later this year and into 2025.
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Transcript:
Hi, Nick Colas, from DataTrek Research here. And today, we're going to be talking about stock market bubbles.
Now I got my start on Wall Street in 1986. And I would say over the last now, close to 40 years, the topic of stock market bubbles and whether or not a stock market is in a bubble or not, has been an ever more growing kind of piece of the investment narrative. And to some degree, there's good reason for that.
We've had a number of big blow ups in the market, since even I've just had my career. 87 was the first one, then 2000 to 2002 came after that, and 2007 then obviously, the pandemic crisis, but then the speculative bubble after that. And then there's the big drawdown in 2022.
So it's understandable people want to talk about this topic and focus on it. And the question right now is with the s&p and NASDAQ up 25 to 30% over the past couple of months since the October lows, are we in a bubble today? And my answer is probably not. And I'll give you three reasons why.
The first one is, bubbles just don't come in the stock market in isolation that things happen around them. So for example, the IPO market gets really hot a stock market bubble and not just in terms of the number of IPOs done, but how much they trade up on the first day. And during bubbles, they trade up anywhere from 25 to 40%. On the first day, on average, that was a case in the late 1990s, for example, but also in late 20 and early 2021. The IPO market was very frothy and things just traded up right away on the first day. That's when we didn't know that you have a lot of speculative excess going on, particularly in the retail and investment population.
The second thing I look for is a really big landmark m&a deal. So for example, AOL Time Warner in early 2000 was really the cap on the dot com bubble, a big tech company with an inflated stock price, buying a more traditional media company. And that showed you tech valuations were just way too high. Then in 2007, we had a big LBO by KKR with a utility in Texas called TXU. And that told you the LBO slice of the market was overheated in the mid 2000s. I always look for a hallmark deal, we really haven't had one yet.
And the third thing I look for is something that we update and track and kind of referenced is with the phrase a double is a bubble. So if stock prices double in a year, you know things are unsustainably high, and the NASDAQ is especially useful, it's useful to use this measure, when looking at the NASDAQ, for example, the NASDAQ doubled through February 2000. And that told you tech stocks were in a bubble.
The reason a double is a bubble is a good indicator is because fundamentals can never justify the doubling of a major liquid stock market in the course of a year. So you know that speculative excess is really working. When you see a doubling of stock prices. And these are index prices on individual stocks, individual stocks can obviously double in a year and not be in a bubble, but the market probably can't.
Now, as much as we're not in a bubble right now, we certainly have the recipe for getting to a bubble later this year and into 2025. And the reason I say that is if you combine two different time periods from the last 40 years, you get to the kind of thing that's a recipe for a bubble.
The first is fed policy. So for example, in the mid 80s, the Federal Reserve thinking that inflation was finally tamed after Paul Volcker kind of killed it in the early 80s. The Fed cut rates from 12 to 6% from 1984 to 1986. And that ignited a major rally in stocks. So from the two and a half years from 85 through late mid to q3 87. The s&p 500 doubled. So 85 86 and a piece of 87, were a double type of rally. So we mentioned the double is a bubble. In the case of the s&p if it doubles in less than three years. That's also the sign of a bubble. And you know what happened after that the stock market crash in October 87.
The second thing you need for a bubble is a really hot new technology. So the dot com bubble in the late 90s is a perfect example of that. We had this brand new thing very interesting, very exciting. A lot of new companies being created a lot of new companies going public. And that creates the kind of backdrop that a speculative mania can feed off of. So we do have the two ingredients for a bubble forming right now. We have the Fed talking about cutting interest rates hasn't done it yet. But it's talking about it and the markets taken some comfort in that.
And we have a new technology with Gen AI that could potentially spark a lot more enthusiasm in the market than it currently has. So as much as we've seen things like Nvidia go up or SMCI go up. The NASDAQ really hasn't taken as much notice we haven't gotten that doubling yet. But if you combine the Fed policy issue that we just discussed, with this new technology and interests around it, we certainly have the recipe for a bubble later in the year.
So my bottom line is for right now, we don't have a bubble. Could we get one? Absolutely. And I would just think about that double is a bubble framework for thinking about when the NASDAQ in particular gets way overheated, we're not there yet. We're only about 40% on the NASDAQ right now. But if we get there, obviously, then you gotta be very careful looking at the market from that point forward.
So the bottom line is don't worry about a bubble for now. But be vigilant and think about the issues of Fed rate policy, and the spec tech bubble forming around generative AI as kind of the signposts to think about the issue.
I hope you enjoyed the video, please like and subscribe if you did. And also we have a website datatrekresearch.com where you can go and sign up for a two week free trial for our work, no credit card or any other personal information required. And we hope you do. Thanks a lot and have a great day.
