Home » Motivate » Financial Independence » Dividend Power Week In Review – Are We In A Bubble?
Are We In A Bubble

Are We In A Bubble?

Are we in a bubble? I am of course talking about a stock market bubble. There are quite of a few smart money investors who are saying that the stock market is in a bubble or at the least very overvalued. On the other hand, there are some investors saying that not much has changed, and we will see low interest rates for years and the Fed will continue providing monetary stimulus supporting the stock market.

Are We In A Bubble
Are We In A Bubble?

What is a bubble anyway? Investopedia defines a bubble as

“A bubble is an economic cycle that is characterized by the rapid escalation of market value, particularly in the price of assets. This fast inflation is followed by a quick decrease in value, or a contraction, that is sometimes referred to as a “crash” or a “bubble burst.”

There have been some famous bubbles and not all are related to stock markets. The first recorded bubble was the tulip bulb bubble in Holland, which is referred to as Tulip Mania. It seems little crazy that tulip bulbs would lead to a bubble and subsequent recession but that is exactly what happened from 1634 to 1637. Interestingly, the tulip bulb bubble started when Holland’s wealthy began collecting certain tulip strains. Demand increased and prices went up. There was a feedback loop as more investors entered the market. A futures exchange was created allowing traders to trade contracts with no delivery of tulip bulbs driving prices higher. Fortunes were literally made and lost overnight. Eventually, the bubble burst and prices crashed when buyers did not show up for a tulip bulb auction. Reportedly, this may have been related to an outbreak of the bubonic plague. This led to a panic and a collapse in tulip bulb prices.

I find the story of Tulip Mania interesting. The moral of the story though is that speculative behavior that drives asset prices higher occurs. In modern times, in the U.S., the three bubbles that come to mind are the stock market in 1920s before the crash in 1929, the dot-com bubble, and the housing bubble in the mid-2000s.

In U.S. the 1920s was a period known as the “Roaring Twenties”. The end of WWI and movement of rural Americans to cities drove growth as industrial companies grew rapidly. The stock market rose rapidly during this time for about nine years. Reportedly though, overproduction in the agricultural sector was one factor starting the economic slow down. However, steel production was declining, construction was slow, automobile sales dropped, and consumers had high debt due to easier credit terms. The stock market crash began in September, but this was viewed as healthy correction. But on September 20th, the London Stock Exchange crashed. Selling continued in the U.S. until “Black Thursday” on October 24th when the market plunged 11%. Friday provided respite as Wall Street bankers intervened to buy stocks at higher prices than in the market. But selling continued on “Black Monday” down 12.82% and Tuesday down 11.73%. A period of ups and downs ensured and by July 8, 1932 the Dow Jones Industrial Average or Dow 30 was down a mind boggling 89.2% in about three years. The Dow did not recover its previous highs until November 23, 1954 or 22 years later.

In modern times I have lived through two asset bubbles as an investor. The dot-com bubble involved speculative buying and selling of internet and telecom stocks. Some of this was driven by excitement for new technology. But it was also driven by the perception that profits and fundamental did not matter. Some companies that were trading at record highs during that time are still below those highs. For instance, Cisco Systems (CSCO) has the distinction of one-time having the largest market capitalization. During the dot-com boom Cisco reached a peak valuation of approximately $555.4 billion. The company’s stock price plummeted after the dot-com boom and it still has yet to reach the highs of that era. In any case, the speculative excess of trading in dot-com stocks led to a boom and then collapse in stock prices and about $5 trillion in market value wiped out.

The U.S. housing bubble occurred in the mid-2000s as an after effect of the dot-com boom. Money from the stock market flowed into real estate and prices started to rise. Low interest rates combined with lenient lending standards drive prices higher. Does anyone recall no-income verification loans and the interest only mortgage loan? Eventually, higher interest rates, defaults, and losses in the sub-prime markets led to a collapse in housing demand and prices. The widespread damage to the financial system required large-scale government intervention and buying of bonds by the Federal Reserve. Some financial companies declared bankruptcies and others were forced into buyouts by larger more well capitalized firms. Do you recall names like Bear Stearns, Lehman Brothers, CIT Group, General Growth Properties, Thornburg Mortgage, Colonial BancGroup, Ambac Financial, BankUnited, and Washington Mutual? GM and Chrysler filed for bankruptcy and kept going by government bailouts. Other companies also non-financial declared bankruptcies. Today, we are still living with the aftereffects of this bubble. For one, the Fed never fully sold off all the assets it bought during that time.

So, are we in a bubble? The main points of the above stories are that speculative excesses can occur. There is no doubt in my mind that the market is at least very overvalued. One only has to look at the S&P 500 PE ratio or the Shiller PE Ratio to realize that. We have certainly had a rapid escalation of some asset prices including the stocks and gold. In my opinion stock prices are being driven by the Fed providing large amounts of monetary stimulus, fiscal stimulus from the CARES Act, new investment platforms that are changing the way people invest, underemployed who are entering the stock market for the first time, and possibly no commissions. In any case, we have not yet had a rapid decline in stock prices except for the end of last week.

That said, bubbles can go one for some time. Recall that the Tulip Mania was about three years. The dot-com boom was about two to three years in duration. The housing market was also a few years. Today, internet and social media are profitable for the most part. They also seem to be navigating the coronavirus pandemic better than many other sectors and, in some cases, benefitting. On the other hand, many sectors and companies are operating at levels below the pandemic. So, are we in a bubble? I personally think that we have some excess although there are some stocks trading in bubble territory.



Affiliate

Try the Simply Investing Report & Analysis Platform.

  • 6,000+ stocks on the NYSE, NASDAQ, and TSX
  • 120+ metrics and financial data updated daily
  • Portfolios, watch lists, dividend income, e-mail alerts, etc.
  • List of top ranked stocks based on the 12 Rules of Simply Investing
  • 14-day free trial

Try the Simply Investing Course

  • 10 modules and 27 lessons
  • Access to 21-years of stock data and portfolio tracker
  • 1-month free access the Report & Analysis Platform
  • Lifetime access to the course and 30-day money back guarantee

Use the Simply Investing Coupon Code DIVPOWER15 for 15% off.



Dogs of the Dow in 2020

I started a new blog post that I will periodically update, the Dogs of the Dow in 2020. Take a look at it. I discuss the history of the Dow Jones Industrial Average or Dow 30. I cover the Dow 30 as of the most recent update on August 31, 2020. Next, I write about the history of the Dogs of the Dow strategy and the Dogs of the Dow in 2020. I also discuss how the strategy works, limitations, and why it works.

Coronavirus Dividend Cuts and Suspensions List

I updated my coronavirus dividend cuts and suspensions list this past Wednesday. The number of companies on the list has risen to 378. We are wellover 10% of companies that pay dividends having cut or suspended them since the start of the COVID-19 pandemic. The number of companies on the list continues to rise each week. 

This past week there were three companies added to the list, but I also included 21 companies that I had previously missed. The three new companies were Raven Industries (RAVN), Frontline (FRO), and Royce Value Trust (RVT).

The 21 companies that I missed previously were Range Resources (RRC), Ark Restaurants (ARKR), QEP Resource (QEP), Allegiant Travel (ALGT), Triumph Group (TGI), Ruth’s Hospitality Group (RUTH), Daktronics (DAKT), Quad/Graphics (QUAD), Liberty Oilfield (LBRT), R.R. Donnelly & Sons (RRD), Haldor Energy (HNRG), Chesapeake Energy – Preferred (CHK), Inter Parfums (IPAR), BBX Capital (BBX), Northern Technologies International (NTIC), DMC Global (BOOM), Arch Resources (ARCH), Yum China Holdings (YUMC), O-I Glass (OI), Standard Motor Products (SMP), and Universal Logistics Holdings (ULH).

Note that Kimco Realty (KIM) reinstated its regular quarterly cash dividend but at a reduced rate of $0.10 per share. The old quarterly dividend before the suspension was $0.28 per share.

Stock Market Volatility – CBOE VIX

The CBOE VIX spiked this past week to approximately 31. Since bottoming a couple of weeks ago volatility is now trending up. This is the highest since mid-July. It still remains elevated relative to the long-term average. The long-term average is approximately 19 to 20. I continue to believe that volatility being driven by new infections, vaccine developments, federal stimulus, and unemployment numbers.

A screenshot of a cell phone

Description automatically generated
Source: Google

The number of weekly new unemployment claims declined quite a bit to 881,000. This is good news and down after ticking up over one million for two weeks in a row. However, the improvement and drop below one million is largely artificial since it includes 238,000 temporary workers for the U.S. Census. Hiring for employees temporarily furloughed in public education are also starting to return to work as schools restart. In any case, private sector hiring rose by 1 million, which is down from 1.48 million in July. The lower number means that the pace of hiring is slowing. However, the good news is that the unemployment rate fell to 8.4% in August 2020

Note that there are still about 11.5 million more unemployed workers than before the pandemic started. Another concern is that the number of permanently laid off workers is rising to 3.4 million, which rose by 534,000 in the past month.

Why did the VIX spike? It would seem that with the improvement in unemployment and the fiscal stimulus from the CARES Act still having a positive (but fading) effect, and large monetary stimulus from the Fed the VIX should come down even more. I believe that spike was at least partially due to an overbought market. Additionally, I think that the lower growth rate in employment gains is now being priced into the market. Lastly, new coronavirus infections in the U.S. is still running at about 40,000+ per day and daily deaths are about 1,000 per day. These are not small numbers.

Fear & Greed Index – Are We in a Bubble?

I also track the Fear & Greed Index. There are seven indicators in the index. They are Stock Price Breadth, Put and Call Options, Stock Price Strength, Junk Bond Demand, Safe Haven Demand, Market Momentum, and Market Volatility.

The current reading is now at 59, which is in Greed. The index plunged 19 points from last week. Note that I have been pointing out that one the index goes over 60 it rarely stays there that long. Further, a value near 80 usually means that it drops fairly fast afterwards, which is exactly what happened.

The drop is largely due to a rapid decline in tech stock prices. They were arguably overvalued. This has meant that the S&P 500’s momentum and the number of advancing stocks relative to declining stocks has dropped. The big moves though came from bonds outperforming stocks the jump in the VIX discussed above. This meant that the Safe Haven Demand sub-index was in Fear and Market Volatility was in Extreme Fear.

A screenshot of a cell phone

Description automatically generated
Source: CNN Business

Market Valuation – Are We in a Bubble?

The S&P 500 is trading at a price-to-earnings ratio of 29.5X and the Schiller P/E Ratio is at about 31.5X. These have come down a full point since last week. Note that the long-term mean of these two ratios are 15.8X and 16.7X, respectively. I continue to believe that the market is largely overvalued at this point despite the large declines at end of last week. I still think that caution is warranted for investors.

S&P 500 PE Ratio

A close up of text on a whiteboard

Description automatically generated
Source: multpl.com

Shiller PE Ratio

A close up of a map

Description automatically generated
Source: multpl.com

Here are my recommendations:

If you are unsure on how to invest in dividend stocks or are just getting started with dividend investing. Take a look at my Review of the Simply Investing Report. I also provide a Review of the Simply Investing Course. Note that I am an affiliate of Simply Investing.

If you are interested in an excellent resource for DIY dividend growth investors. I suggest reading my Review of The Sure Dividend NewsletterNote that I am an affiliate of Sure Dividend.

If you want to simplify your portfolio management and stop using spreadsheets take a look at my article on Passiv – A Modern Portfolio Management Website ReviewNote that I an affiliate of Passiv.

If you would like notifications as to when my new articles are published, please sign up for my free weekly e-mail. You will receive a free spreadsheet of the Dividend Kings! You will also join thousands of other readers each month!


*This post contains affiliate links meaning that I earn a commission for any purchases that you make at the Affiliates website through these links. This will not incur additional costs for you. Please read my disclosure for more information.

Website | + posts

Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.

Related Posts

7 thoughts on “Dividend Power Week In Review – Are We In A Bubble?

  1. Thanks , I’ve recently been searching for information approximately this subject for a long time and
    yours is the best I have came upon till now. However, what about the bottom line?
    Are you certain about the source?

Leave a Reply