|
Bubbles or Balloons?
By Clif Droke October 28, 2007
“If
in the last few years you haven’t discarded a major opinion or
acquired a new one, check your pulse, you may be dead.”
[Frank Gelett Burgess] It
has become popular to the point of redundancy to refer to any
extended bull market as a “bubble.”
The
private equity trend? That’s
a “bubble” by the definition of the bubble experts.
A
hot sector that catches the interest of investors for any length of
time will always be consigned to the bubble category by the
financial scribes. Consumer
credit is always relegated to the bubble category.
And a price spike in any commodity is sure to bring the
bubble police to the scene. Even
more perniciously, whenever stocks prices rise for any length of
time you can be sure it will be protested every step of the way by
those who scream, “It’s a bubble just waiting to pop!” What
has happened to investors today?
What transformation has influenced their thinking to the
point where they no longer take advantage of what, in the old days,
were called “trends” (as opposed to “bubbles”).
Instead of participating in a prolonged upside move to the
benefit of their bottom lines, investors seem content to sit on the
sidelines and hurl invectives at a market that left them behind long
ago. This
sea change in retail investor psychology is easy enough to trace:
it’s a delayed reaction to the Internet stock crash and bear
market of 2000-2002. This
once-a-generation event catalyzed a new attitude among investors
that has tainted their outlook on the financial markets ever since.
This warped thinking has kept them from fully participating
and reaping the fruits of the 2003-2007 recovery rally in stocks.
It has also sent them ducking for the bomb shelter every time
the slightest hint of fear is felt in the financial markets. To
give you an idea of just how scared the average investor is of the
stock market, take a look at the following chart.
The
above chart shows the trend since 2002 in stock market versus money
market investments. The
public’s love affair with cash has been eclipsed only by its
hatred of stocks. One
of the main reasons for the public’s reluctance to approach the
stock market is the idea, falsely implanted by the financial press,
that stock prices *could* be in a “bubble.”
Moreover, that bubble could burst at any minute.
Investors
were recently reminded in gruesome terms of the horror that occurred
in October 1987. There
were myriad newspaper articles featuring a grisly flashback of Black
Monday detailing how countless investors lost their shirts in the
crash 20 years ago. No
wonder then that the latest investor sentiment polls show the retail
investor has once again gone into the bearish camp.
The bulls have all but evaporated in their fear of another
October Massacre. Here
are just some of the headlines from the Financial Times that have
shown up in the past two weeks underscoring the widespread fear of
bubbles: “Bonanza
for emerging market stirs bubble fears” “Fears
of bubble as Fed rate cut pushes equities to record high” “Rush
into green arena raises bubble fears” “Bubbles
leave a residue that can take years to shift” “Concerns
continue over credit bubble” The
problem with today’s fixation over bubbles in the financial
markets is that our understanding has been skewed by the terrible
experience of 2000-2002. As
touched on earlier, many investors had the harrowing experience of
losing everything during the great “tech wreck” of those years.
This left a deep and abiding scar in their minds, one that
even today is sore to the touch. The
2000-2002 bear market/recession and more recently the housing market
downturn, have led to an endless tirade in the popular press against
bubbles. Everywhere you
turn, you’re barraged with bubble talk.
Yet
the term “bubble” is actually a misnomer.
There’s a better word to describe what happens when an
asset becomes severely overpriced in relation to underlying value.
We’ll see what that is in a minute. Before
we can discuss any issue intelligently we have to define our terms.
This is something that’s rarely done in public debate these
days. So let’s define
what exactly constitutes a “bubble.”
Webster’s
Dictionary defines a bubble as “something that lacks firmness,
solidity, or reality.” It
is also defined as “a delusive scheme.”
Can this be applied in any way to the stock market? It
would be well beyond the scope of this article to offer a
comprehensive and detailed discussion of each of these points.
Instead, let’s do a cursory examination of each one. Does
the stock market lack firmness?
Stocks are currently 36% undervalued according to the IBES
Valuation Model. Does
that sound like a market sitting on a weak foundation?
Some
critics have suggested that this valuation is skewed by earnings and
profit margins being above trend.
But as Mark Dodson pointed out, “if forward earnings on the
S&P 500 fell back to their long term trend (currently around
$88), the stock market would still be more than 20% undervalued.” He
continues, “If forward earnings fell off an unprecedented cliff
going as far under trend as they have since we have data (this last
happened in February 2003 near the bottom of the three year bear
market), the stock market would be approximately 5% undervalued. “Current
valuations have the ability to absorb some unprecedented shocks to
earnings,” he concludes. What
about the possibility that the bull market in stocks is a
“delusive scheme”? If
there is any truth to this then it’s
because investors see no hope for the future of companies in the After
giving it some thought, I think you’ll agree that for someone to
have a long-term bearish bias on the stock market is tantamount to
saying that one doesn't believe in the power of human productivity.
In other words, they are bearish on the productive capacity of
Americans in the aggregate. Yet
Americans have shown themselves to be the most productive,
innovative and industrious workers in the world for well over 100
years. Why would anyone want to “short” that track record? When
investors get bearish on stocks, long-term, they are also saying
they don’t believe in the power of technology to increase
productivity and the aggregate demand for goods and services. What
could be more misguided than to assume technology’s demise? If
anything, the surface has only been scratched here and there’s a
lot more potential for future discovery and application in this
realm than most of us realize. A
perma-bear asserts the following credo (in the negative): “I
don’t believe in human productivity or ingenuity, nor do I believe
in the power of technology to expand economic performance, nor do I
believe that the basic pursuit of the profit motive will benefit
business corporations to any substantial degree in the long term.” This
sentiment contradicts the great principle of free enterprise upon
which this country was founded.
Our ancestors would blush if they could read our financial
press today, laced as it is with bubble talk. “Bubble”
isn’t the best word to describe today’s stock market.
A bubble is a thin veneer held together temporarily by
nothing more than air. There
is no grounding or foundation for a bubble.
There
can be bubbles in the financial markets when the basis behind the
increase in an asset’s price is non-existent.
For instance, the rapid inflation of the stock price of a
shell company that doesn’t even exist is a bubble in the truest
sense. We saw this more
than a few times during the late ‘90s Internet stock boom.
In such cases, when the inevitable collapse of the
company’s stock price comes it can be likened to a bubble bursting
since there was nothing behind it in the first place.
Moreover, a bubble that has burst can never be re-inflated. What
about the stock price of a company that makes essential products or
services? Can there
ever truly be a “bubble” in the equity price of such a firm?
Let’s
take IBM as an example. This
famous company has been around for nearly 100 years and is the
largest information technology employer in the world with more than
350,000 employees. It
also holds more patents than any other Could
there ever truly be a “bubble” in the stock price of IBM? No,
there couldn’t. While
there may be periods when IBM’s stock price exceeds the
company’s true value, there’s no denying that IBM’s stock has,
in opposition to Webster’s bubble definition, “firmness,
solidity, and reality.” A
better term to describe an asset price that has temporarily expanded
beyond the bounds of normalcy would be “balloon.”
Unlike a bubble, a balloon has greater elasticity and can
expand to many times its original size without imploding…provided
its construction is strong enough and its rate of
inflation/deflation is done at a controlled pace.
So there could theoretically be a balloon in IBM’s stock
price but this isn’t the same as a bubble. Can
there ever be a bubble in the truest sense of the word in the broad
market for major stocks and commodities?
No, because there will always be a baseline demand for them
regardless of the vagaries of investor sentiment and despite the
occasional manias that may develop.
Once
a bubble bursts it never comes back!
A balloon can be rapidly deflated and stay deflated for a
long time before eventually being re-inflated.
Therein lies the distinction. Natural
Resources The
XAU gold/silver index closed nearly 3% higher on Friday, Oct. 26, to
end the week at a new all-time high of 182.41.
The Amex Gold Bugs Index (HUI) closed at 420.59 for a gain of
2.79% on Friday. The
CBOE Gold Index (GOX) call/put open interest ratio is still showing
more call buying than put buying among the traditionally “smart
money.” The GOX
call/put ratio has been the key to the PM stock sector rally from
its beginnings in August. It
still hasn’t turned bearish yet as Friday’s (Oct. 26) reading of
0.22 shows a net bullish stance among the smart money traders.
This shows that market psychology is still skewed in favor of
the bullish trend for the PM stocks.
The
leading silver stocks have recently been catching up to the leading
gold stocks on the upside. Of
the actively traded silvers that have yet to breakout above key
interim resistance, Apex Silver (SIL) and
The
Amex Oil Index (XOI) closed at a new high level of 1,506 on Friday
while the Natural Gas Index (XNG) also made a new high by closing at
560.50. As I pointed
out in last week’s commentary, there are some bullish patterns
still visible in the charts of the leading oil and gas sector
stocks. It
was asked last week, “Could the oils be gearing up to play
‘catch up’ to the natural gas stocks?”
The answer to that question was a decisive “yes” based on
the negative investor sentiment that was showing up, including the
front cover of the October Futures magazine.
This
cover (which was shown in last week’s commentary) depicted a
fearsome looking bear and the headlined asked, “Is the bear
looming over energy markets?”
From a contrarian standpoint that’s all we needed to see to
know that oil/gas stocks had more upside.
The crude oil price closed Oct. 26 at an all-time high of
$91.86. Clif
Droke is the editor of the daily Gold & Silver Stock Report.
Published daily since 2002, the report provides forecasts and
analysis of the leading gold, silver, uranium and energy stocks from
a short-term technical standpoint.
He is the author of several books on financial markets,
including most recently “How to Read Chart Patterns for Greater
Profits.” Visit www.clifdroke.com
for more info.
© 2004-2007 Biiwii.com
Views presented in guest articles are those of the authors and do not represent those of Biiwii.com. Biiwii.com does not recommend that any trading or investment positions be taken based on views expressed on this site. If you speculate or invest it is suggested that you consult a financial advisor qualified in your area of interest. For more detailed information and full terms of service, see "About & Terms" here. |
