Stock Market Bubble: These 2 Charts Should Scare You

I'm not one to be obsessed about stock market bubbles. Yet, sometimes it's hard to ignore the possibility that we could be in the midst of one when you consider that the S&P 500 (SNPINDEX: ^GSPC  ) is not only at an all-time high; it's towering above its former peaks.

You can see this in the chart below, which traces the leading stock market index back to the early 1960s.

^SPX Chart

Two things stick out here. First, the two former peaks were associated with the irrational exuberance pervading the Dot-com and housing bubbles in 1999 and 2007, respectively. And second, we're now considerably higher than even those.

While it's impossible to identify any single reason for the current state of euphoria, there's no denying the fact that interest rates are continuing to take their toll, as stocks and fixed-income investments are typically assumed to be alternatives. When rates are low, capital flows into equities; when rates are high, it pours into the bond market.

Just how low are interest rates today? While long-term rates have gradually begun to tick up, the yield on the 10-year Treasury is still near the historic trough from 2012. Meanwhile, short-term rates continue to hover just above the so-called "zero bound."

That stocks are at an all-time high, however, doesn't answer the question of whether they're fairly priced. To determine this, one must look at valuations. But here too the same story appears to be unfolding.

This chart shows Robert Shiller's widely followed measure of stock market valuations. And as you can see, aside from the housing bubble, the Internet bubble, and the 1920s, stocks have never been as dearly priced.

Now, just to be clear, this doesn't mean that we're in the midst of a bubble per se. As Shiller himself recently noted:

We don't know what [the stock market] is going to do. There could be a massive crash like we saw in 2000 and 2007, the last two times it looked like this. But I don't know. ... I think, realistically, stocks should still be in one's portfolio -- maybe lighten up. And also: more abroad than usual, because the U.S. is really high relative to other countries.

At the end of the day, in turn, while it's impossible to predict what will happen next, this is something investors should certainly be keeping an eye on.

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  • Report this Comment On June 30, 2014, at 12:59 AM, SkepikI wrote:

    Not to mention the fact that we have NOT HAD a meaningful correction in what 5 years? You don't have to scare me John, I am already petrified.... and largely out.

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