Thursday marks eight years since the low point of the last bear market on Wall Street. On March 9, 2009, the Dow Jones Industrial Average closed at 6,547.05. Since then, it has more than tripled. If you’d invested twenty thousand dollars in the Dow index eight years ago, it would now be worth about sixty-four thousand dollars.
The vast majority of the market’s gains came while Barack Obama was President, but since Donald Trump was elected the Dow has tacked on more than twenty-five hundred points, or about twelve per cent. Last week, it closed above twenty-one thousand for the first time, and we also saw the I.P.O. of Snap, the social-media company that owns Snapchat. At the end of Snap’s first day of trading, the market placed a notional valuation on the firm, which has always operated at a loss, of thirty-four billion dollars. “Since November 8th, Election Day, the Stock Market has posted $3.2 trillion in GAINS and consumer confidence is at a 15 year high. Jobs!” Trump boasted on Twitter.
Looking at numbers like these, many people’s reaction is to try to get in on the action. Since October, about seventy-five billion dollars of new money has flowed into U.S. equity funds and exchange-traded funds, according to figures from the Investment Company Institute. Evidently, investors believe that Trump can keep the bull market going.
They might be proved right—but I doubt it. That’s not an opinion driven by my animus toward Trump’s politics, or even my belief that investors are ignoring the economic and financial risks inherent in having a man like him in the White House. (My colleague James Surowiecki wrote recently about the business world’s view of Trump as a risky but not completely uncertain bet.) My skepticism about stocks is primarily based on nonpolitical factors: valuation, monetary policy, and herding behavior—all of which can play key roles in driving the market.
I’m not arguing that we are in a full-on speculative bubble of the sort we saw in stocks during the late nineteen-nineties and in the housing and mortgage markets during the early two-thousands. Although the stratospheric valuation placed on Snap last week should be seen as a warning sign—in the past few days, the company’s stock has fallen back—it can’t be compared to the rash of dot-com I.P.O.s in 1999, or the proliferation of “liar loans” in the mortgage market between 2004 and 2007. Still, the price-to-earnings ratio of the S. & P. 500 index, which is perhaps the most widely followed valuation metric, now stands at more than twenty-six.
That’s not as high as it was during the late nineteen-nineties, but it exceeds the levels seen during any other bull market since the Second World War. Other valuation measures, such as Robert Shiller’s cyclically adjusted P/E ratio, and the late James Tobin’s “Q ratio”—which measures the price of investment assets relative to their replacement cost—are also emitting warning signals. Andrew Smithers, an investment analyst who tracks both of these metrics closely, wrote recently, “Although the overvaluation of the stock market is well short of the extremes reached at the year ends of 1929 and 1999, it is near its other previous peaks of 1905, 1936, and 1968.”
Stock-market bulls respond to this type of analysis with two counterarguments. First: with interest rates at very low levels, stocks still represent better value than bonds and other interest-bearing investments. Second: even overvalued markets can sometimes rise a lot further before they go pop.
Regarding the first argument, there can be no doubt that one of the primary drivers of the bull market has been the Federal Reserve’s determination to keep the cost of borrowing very low. But the Fed is now raising interest rates, and it may well be about to step up the pace of monetary tightening. At their policymaking meeting next week, Janet Yellen, the Fed chair, and her colleagues are widely expected to raise the federal funds rate by a quarter point. Based upon recent projections from the Fed, it looks like there will be at least another two additional hikes before the year is out.
Rising interest rates don’t necessarily presage lower stock prices, but the two things have often gone together. They did in the mid two-thousands, the late nineteen-nineties, the late seventies, and the late sixties. The early nineties were an exception—one that can be explained by an unexpected surge in productivity and G.D.P. growth, which, in turn, boosted corporate profits. To be sure, something like this could happen again: Trump is promising as much. But looking at the already low unemployment rate (4.8 per cent) and weak productivity figures, few economists think a sustained growth spurt is likely.
Why, then, is the market still going up? Undoubtedly, there is a “Trump factor.” Many billionaire hedge-fund managers have welcomed the President’s promise of lower taxes and less regulation. “If nothing else happens, that releases animal spirits,” David Tepper, the head of the hedge fund Appaloosa Management, told CNBC on Wednesday. In the current environment of decent growth, low inflation, and pro-business policies, Tepper added, investors “can’t be short.”
That last comment, I suspect, is the real key to the market’s buoyancy. Professional investors are buying stocks because others are buying, and they fear that if they deviate from this pattern they will be punished. (George Soros was punished late last year, when he shorted the market and, reportedly, lost a billion dollars.) Keynes warned us that herding behavior can drive markets far from reasonable valuations, and that the mispricing can last for a considerable period. Referring to short sellers who try to make money by selling high-priced stocks, he is reputed to have said, “The market can stay irrational for longer than you can stay solvent.”
It is folly, then, to predict what will happen on Wall Street tomorrow, next week, or next month. With many investors still upbeat, stock prices could rise further for a time. Eventually, however, overvalued markets do correct and revert to levels justified by economic fundamentals. When that happens, it is seldom pretty. There is no reason to believe things will be different this time.