We see a stock market bubble but prefer to close our eyes.

Summary:  Bubbles in the information age differ from those of simpler times. Now we have real-time data showing our folly. Here’s a brief review, another in our series of posts about this mad cycle. Listen while you read and you’ll hear the stock market roaring to the moon.  {1st of 2 posts today.}

“You can’t cheat an honest man.”
— Title of W. C. Fields movie, describing the essence of bubbles (1940). Bubbles are consensual hallucinations. Each participant chooses to join.

Soyuz TMA-12M Prepares To Launch

(1)  Goldman tells the story

As usual, Goldman gives us clear analysis, in mild professional language — seeing events earlier than the rest of the pack. (Via Zero Hedge). The 21st century differs from anything seen before. We see it as distinct phases; future generations will see it as one event (as we’ve combined what participants saw as separate events into the War of the Roses and the Napoleonic Wars).

Stocks with attractive valuation are rare in the current environment of stretched share prices. The aggregate S&P 500 trades at 17.3x forward EPS and 10.2x EV/EBITDA. The only time during the past 40 years that the index traded at a higher multiple was during the 1997-2000 Tech Bubble. The median stock sports a P/E and EV/EBITDA of 18.0x and 11.0x, respectively. These valuations rank in the 99th percentile of both P/E and EV/EBITDA multiples since 1976.

Goldman: valuations

Valuation ratios are deceptively simple, as their interpretation relies on larger factors such as interest rates and the economy’s expected future growth rate. If fears of secular stagnation prove correct, people today pay big money for growth that will not arrive. Also likely to be disappointed are people hoping to sell at valuations like those of 1999-2000. Those were based on GDP growth rates almost twice ours. From 1996-2000 GDP grew at ~4.5%; it was 7.4% in Q4 1999 — fueling dreams of our economy roaring like never before.


(2) The biotech bubble

Every bubble has a heart from which the euphoria is pumped out into the wider society. In this cycle it’s the biotech industry. Like the railroads in 1840s and the internet in the 1990s, the biotech industry has a great future. But like its predecessors, valuations have grown beyond realistic bounds. For news from the front see this: “Forget the tech bubble. It’s the biotech bubble you should worry about“, Max Nisen, Quartz, 19 February 2015. — Excerpt:

Big pharma firms and investors have been showering billions on speculative companies that have never produced a viable drug. For four years running, biotech stocks have risen faster than any other sector of the market in the United States. Health care set new records last year for both IPOs and M&A spending. … Cheap debt, a frenzy of publicity for research that hasn’t yet led to any products, and obscenely high pricing for the medicines that make a difference are all adding fuel to the fire.

As usual, the extreme madness appears in the paper-manufacturing business: the people creating new companies and doing Initial Public Offerings. Fortunes are made by farming gullible investors. Drugs go through five phases from conception to approval: preclinical work, 3 rounds of testing on people, and getting FDA approval. The number of IPOs having only drugs in the first 3 phases has grown to insane levels.

Biotech IPOs by stages
From Quartz, 19 February 2015.

Why are these bad investments? The odds are better at Las Vegas than for early stage drug development projects, and at Vegas you get free drinks served by pretty ladies. Look at the probability of success:

Biotech: Success rates by phase
Biotech: Success rates by phase. By KMR, 8 August 2012.

Printing paper for gullible investors

Bubbles just don’t happen even in the most favorable climate; they’re made. Creating start-ups in a hot market is easier than drilling for oil, and more profitable. Investors give up their money more easily than the Earth yields its treasure. The complex of venture capitalists, attorneys, and investment bankers have constructed a money magnet.

Another note from the front lines: “Look at how quickly the values of multi-billion-dollar startups have multiplied“, Nitasha Tiku, The Verge, 20 February 2015 — “A quick note on how profitability relates to valuations: it doesn’t! At least not yet.” See the following graphic; see the bubbles grow over time! Size of the circle shows the dollars raised in each deal. Go to the article to see this as an interactive graphic, where you can click on each dot for details. Click to enlarge.

Startup Sizes
Startup sizes by year. From The Verge, 20 February 2015. Click to enlarge.

Other articles about the bubble

  1. Stock market bubble warnings grow louder“, CNN, 19 August 2014 — “Some of the brightest minds in finance are sounding the alarm about a stock market bubble.”
  2. US equity markets in ‘dotcom style’ bubble“, The Telegraph, 28 November 2014 — “The UK’s top professional investors think most asset classes are overvalued after years of easy money conditions.”
  3. {CEO Elon Musk} Says Tesla’s China Sales Fell, No Profit Until 2020“, Bloomberg, 13 January 2015 — My personal favorite bubble stock.
  4. The billion-dollar companies Silicon Valley investors ought to fear“, Financial Times. 20 February 2015 — “Late-stage private companies have not endured the scrutiny of the IPO process.”

For More Information

Other posts about our new and strange world:

  1. Will 21st Century USA have a surprise boom, as did the 19th Century UK? — About the 1840s railroad boom.
  2. Four graphs showing a nation in decline. An unnecessary and easily fixed decline.
  3. The new tech bubble takes us to a new world. A mad world.
  4. Watch corporations strip-mine their future (and ours).
  5. America enjoys a time of sunshine in Hell. Let’s use the time wisely.
  6. A guide into the weird numbers that run our world, describing both financial bubbles & climate change.
  7. Let’s ignore another warning from the BIS. Do we enjoy paying for burst bubbles?
  8. How we’ve become accustomed to bubbles bursting the economy, instead of fighting them.

5 thoughts on “We see a stock market bubble but prefer to close our eyes.”

  1. Something is happening.

    It was off-topic for this thread, but odd things are happening out there.

    The Baltic Dry Freight Index of shipping rates continues to make new record lows. Daebo International Shipping Co. Ltd (of Korea) has filed for bankruptcy, following Copenship (Denmark) and Winland Ocean Shipping (China).

    Copper prices are breaking support while oil prices have crashed.

    As usual during such events, we’re in the dark. Just like during August and September 2008 (although that was on a larger scale, of course).

    1. When it gets down to it — talking trade balances here — once we’ve brain-drained all our technology into other countries, once things have evened out, they’re making cars in Bolivia and microwave ovens in Tadzhikistan and selling them here — once our edge in natural resources has been made irrelevant by giant Hong Kong ships and dirigibles that can ship North Dakota all the way to New Zealand for a nickel — once the Invisible Hand has taken away all those historical inequities and smeared them out into a broad global layer of what a Pakistani brickmaker would consider to be prosperity — y’know what? There’s only four things we do better than anyone else:
      microcode (software)
      high-speed pizza delivery

      1. Johnny,

        (1) The Fed’s FRED database is down, so I cannot show you the numbers. But your worries are unwarranted. Despite the US dollar being overvalued — hence the US running a structural trade deficit — exports as a fraction of GDP have steadily risen for several generations. As the US grows richer, we move to increasingly high value-added products. However, we’ve maintain our position as a strong materials exporter, largely due to better tech allowing high wage workers in this sector to boost their productivity.

        (2) There is no data suggesting the falling prices of shipping and industrial materials results largely from problems in the US. The best guess is China, with its famously opaque economic data. Perhaps, more broadly, we’re seeing a slowing of growth in the emerging nations — possibly in part due to the rise in value of the US dollar. Third, spending cutbacks in the oil-exporting nations seem likely to be a contributing factor. All in all, it’s too early to say more.

  2. We’re also getting a peculiar housing bubble in which the bottom 90% of the market has collapsed but prices and sales have gone wild on the ultra-luxury top end.

    That the housing market is seriously twisted is apparent by the mortgage conundrum: despite historically low mortgage rates of around 4% for a 30-year fixed rate mortgage, mortgage originations averaged only $357 billion per quarter so far this year, according to the New York Fed. Unless a miracle intervenes in the fourth quarter, 2014 will be the worst year since 2000.

    But home prices have soared 74% since 2000, according to the S&P Case-Shiller index. Unit sales are higher as well. Mortgage originations soared with them during the boom, crashed with them during the bust, and re-soared with them. Now home prices have `recovered’ beyond the bubble highs in many markets, pumped up by big Wall Street players with access to the Fed’s free money. They gobbled up vacant homes for their buy-to-rent scheme. And they’re now stuffing rent-backed structured securities into retirement portfolios via conservative-sounding bond funds. But even these firms are getting cold feet.

    Source: California Housing market cracks in two, high end goes crazy.

    Meanwhile, the financial system has not been reformed. The same kind of risky opaque trades are now being made as back in 2007-2008, but by bigger banks and on a larger scale:

    …when Lehman Bros fell, the financial system froze and world economy almost collapsed. Why?

    The root cause wasn’t just the reckless lending and the excessive risk taking. The problem at the core was a lack of transparency. After Lehman’s collapse, no one could understand any particular bank’s risks from derivative trading and so no bank wanted to lend to or trade with any other bank. Because all the big banks’ had been involved to an unknown degree in risky derivative trading, no one could tell whether any particular financial institution might suddenly implode.

    Since then, massive efforts have been made to clean up the banks, and put in place regulations aimed at restoring trust and confidence in the financial system. But the result in terms of dealing with the basic problem, according to a terrific article by Frank Partnoy and Jesse Eisinger in The Atlantic entitled “What’s Inside America’s Banks?” is failure.

    Financial reform didn’t work. Banks today are bigger and more opaque than ever, and they continue to trade in derivatives in many of the same ways they did before the crash, but on a larger scale and with precisely the same unknown risks.

    Source: Big Banks and Derivatives: Why Another Financial Crisis Is Inevitable, Forbes magazine, 1/08/2013.

    FM will predictably dismiss these facts with the usual “I don’t understand why this has anything to do with a stock market bubble” and “this comment makes no sense” and “these claims are ridiculous since [fill in sophistry here].” Regardless, the rest of us realize full well that the problems in America’s (and the world’s) financial system that produced the Great Crash of 2008 have not been fixed, but merely swept under the rug, and thus are inevitably leading to yet another financial crash. When that next crash will come, no one can say…but when it hits, it’s likely to be even less pleasant than the 2008 global financial meltdown since the world is no longer flush with imaginary home-equity cash to pay for the next bailout.

    1. Thomas,

      Padawan, you are not yet ready to take the trials to become a Jedi. Your grasp of the Force is weak. Stop making predictions like the following, for you are usually wrong.

      (1) “FM will predictably dismiss these facts with the usual “I don’t understand why this has anything to do with a stock market bubble”

      I have written about this often, most recently a year ago (Jan 2014; nothing new since then): Has the Fed blown another housing bubble? I have often railed against our failure to reform the financial system after the crash (but not in the past few years; no point in beating a dead horse).

      (2) “peculiar housing bubble in which the bottom 90% of the market has collapsed”

      It’s not “peculiar” at all. The top of the market is owned by the people who benefit from the increasing inequality, hence can bid up their segment of the housing market. It’s the same dynamic that has helped Tiffany and Sotheby’s but hurt WalMart.

      Also, let’s be more specific. The bottom 90% of homes have not “collapsed”. They are still physically there, and their prices are stable or growing (location, location, etc). Transaction volume has dropped. Who cares, unless you are in the RE biz?

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