Is this a speculative market bubble? What bubble?
By Pierre Belec
NEW YORK (Reuters) - As stocks muscle their way into record ground, Wall
Street is again asking the question: Is this a speculative bubble?
The experts' reply: What bubble? This is a rational market.
Investors continued to be lured to the stock market, pushing the Dow Jones
industrial average to the year's 28th record high on Monday. The index of 30
blue-chip stocks has risen an eyepopping 2,000 points since the start of the year.
Stocks have nearly doubled since Federal Reserve Chairman Alan Greenspan -- the modern-day Nostradamus --
predicted in December 1996 that the Dow at 6,000 was positively out of sight. He questioned what he called investors'
''irrational exuberance.''
Now, the Dow is cruising to 12,000 and the next magic target could be 15,000.
Is the market irrational?
''The market is entirely rational,'' says Richard Salsman, senior economist for H.C. Wainwright & Co., a consulting firm.
''New market milestones tend to bring out the pessimists, who insist stock prices are a bubble.''
Although stocks are ripe for a correction, analysts see only a low probability that the market is heading for a
knockout-type secular bear market, which would bring it down 20 percent or more.
Generally, analysts say that if stocks do correct, it would be within the framework of a cyclical correction in an ongoing
bull market.
Salsman said it is the bubble-ists who are irrational because they have no idea how bubbles form, are sustained or
implode.
''That's why bubble talk ... consists of emotional stories, vague formulations and sensational warnings,'' he said.
If investors were buying stocks regardless of the companies' performances, he said, then people would have a legitimate
reason to worry about a bubble.
''For it would mean the market is lacking the capacity to discriminate effectively, to reward winners and punish losers,''
he said.
But as stocks continue to climb, the voices of negativity and doom are also rising.
The Nervous Nellies say stocks just can't keep shooting for the moon without first coming back to Earth. After all, the
market has climbed for more than 4-1/2 years without any meaningful correction and the average price-earnings ratio is
at a record 30.
Still, some experts say don't worry. Things are still looking up for the greatest bull market in history.
Corporate earnings are expected to post their first double-digit gains since 1997.
There's no global crisis on the horizon that could shake the market. In fact, Asian nations, especially Japan, appear to be
on the comeback trail.
Also, the U.S. stock market has performed well in coping with the roadblocks that have been thrown in its path, such as
the Federal Reserve's interest-rate increase last month of a quarter percentage point -- which had a surprisingly
electrifying effect on stocks.
The market rallied on the small interest-rate rise because it suggested the Fed had realized that in the New Era
economics, where growth is expanding and inflation is low, it is smart to maintain a steady monetary policy.
What about Greenspan's stock market assessment?
The big difference between Greenspan and Nostradamus is that the 16th century French crystal ball gazer hit the bull's
eye more often than the Fed chief with all of his economic models.
And, don't worry about the Fed's monetary policy being the cause of a nasty bear market.
Today's tremendously over-stretched stock prices have created a huge U.S. wealth effect and this consumer-driven prop
would likely come undone after a series of interest-rate increases hammers the market. The risk would be a
market-driven economic recession.
Earnings lovers will be feasting on a smorgasbord of fat profits, with the second-quarter forecast up 11.4 percent from a
year earlier.
The earnings story looks even brighter through the end of the year, with analysts predicting gains of 21 percent each for
the third and fourth quarters.
Wall Streeters are often reminded of that nightmare called ''Tulipmania'' -- the mother of all bubbles that savaged
investors in Holland in the 1630s.
Tulipmania went like this. The price of tulips rocketed 6,000 percent from late 1634 to early 1637. Demand for tulips
was so huge that the bell-shaped flowers were traded on the stock exchanges in Amsterdam, London and Paris.
''Tulip-notaries'' were in charge of the booming business and futures contracts were created for delivery of bulbs at
agreed-upon prices.
Investors made a killing and the boom created a wealth effect in Holland, driving up the price of land and horse
carriages.
The mania came undone as prices plunged 90 percent in less than a year -- after the biggest fool had paid the highest
price. Suddenly, people realized that they were not investing but rather betting on tulip prices.
John Geraghty at North American Equity Services, a consulting firm, said the current stock market does not fit the
definition of a classic speculative bubble.
''A true bubble would be formed if investors took the 'lemming effect' and believed the same story,'' he said.
During the 1630s in Holland, people loaded up on tulips not because they had to buy them but because they believed that
prices were continually going to rise.
''In today's stock market, there's a whole spectrum of people who are buying a wide range of mutual funds and they are
buying not because it is discretionary investing but rather because it is compulsory investment for their 401(k) retirement
plans,'' he said. ''People have to put their pension money somewhere and the stock market is the only game in town.''
Geraghty said the market's strong fundamentals, including rising corporate earnings, have justified the high valuations of
stocks.
But the classic fundamentals are really not that important for investors.
''Money will be flowing into that particular pot, no matter what the pot does,'' Geraghty said. ''Even if stocks were to
come down, the same amount of money would find its way into the market via those weekly 401(k) contributions.''
But if the experts are wrong, and this turns out to be a market bubble, then watch out.
''Manias can be the profitable phase of bull markets as long as you are astute enough to pick the top,'' says Ed Yardeni,
chief economist for Deutsche Banc Alex. Brown.
''If you overstay your welcome, then you are likely to discover that the enriching illiquidity -- which drove prices to the
moon during the buying frenzy -- can instantly morph into impoverishing illiquidity during the selling panic as prices
tumble back down to planet Earth,'' he said.
(Questions or comments can be addressed to Pierre.Belec(at)Reuters.Com).
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