Occasionally I speak to groups about life, finance, politics and situations I've been in. Sometime around January, I spoke to a group of investment bankers and venture capitalists in Boston and discussed, among other things, a letter I received in February 2000 from Milton Friedman, one of the greatest economists of all time. The letter enclosed a chart that Friedman had made, showing when he expected the Nasdaq and other stock bubbles to burst. It turned out to be right on the money, predicting a peak in March 2000 and then a steep descent.
As you might imagine, the crowd was ecstatically interested, but not in the way you might suppose. What a dozen bankers and brokers wanted to know was not when you know a bubble is about to burst -- but when you know another one is about to start. In a way, their queries make perfect sense. Who wouldn't want to know when a bubble is starting? After all, that's when you make the real dough.
I've been thinking about that a lot lately in our national era of fear. As everyone now knows, the market took a huge dive two weeks ago, perhaps the culmination of a longer, slower dive, and now it's been rallying mightily. The
Dow Jones Industrial Average was down about 14% in a week, and then up about 7% in a week.
CNBC is back to featuring only bulls when the market is rising and only bears when it's falling, and the bulls are saying that the market is oversold and cheap.
Valuation Concerns
However, neither the Dow nor the
S&P 500 is cheap by historical standards. The Dow is about 23 times earnings as I write this, according to the most recent issue of
Barron's, and that's rich indeed for a time of this much uncertainty. The S&P is about 28 times earnings, and that's spectacularly rich for these times, even compared with yields on Treasury bonds and on high-grade corporates. The tech part of the Nasdaq is still, after all these months and a 70% decline, at well over 50 times earnings. You might think that, in times like these, multiples would be much more conservative than they are.
You'd have been thinking without the benefit of renowned investment psychologist Philip DeMuth, whom I often search out for insights about the market. When I recently asked Dr. DeMuth what could make the market rally in times as dreary as ours, he had a dazzling answer. To paraphrase, he said: "Investors loved the bubble. They were hurt when it burst, but they want it back again. They felt good when the market was a bubble, and they want that feeling again."
Feelin' Groovy Again
He might have added that we were all making money in the bubble, and making money is a big part of feeling groovy. Plus, financial institutions can't stay in business if they're not making money. They can't make money if they're constantly selling stocks when the market is falling. So there is a huge community of interest in turning the market around and getting it into hypervaluation mode. This doesn't require a conspiracy, and I do not suggest one. It is the madness -- and the sanity -- of crowds at work, to paraphrase Kenneth Galbraith.
So we get "authorities" saying that high-tech stocks are undervalued at 100 or 200 times earnings, that blue-chips are undervalued at 50 times earnings, and that the market in general in cheap at 30 times earnings in a time of unparalleled threat. If there are enough takers, the bubble might start again.
True, there is no precedent for a high-tech bubble or any other kind of stock bubble starting again so soon after the last one burst. But we're in a time when people crave a thrill and some release from their fears. So maybe the bubble will start again. Some people are already saying (once again) that earnings don't matter.
The problem is that we now know nothing will keep a new bubble from blowing up all over our faces. "Support levels" don't mean a thing. Newsletters don't prop up markets when sellers want to sell. Earnings always end up mattering, and no one ever knows when to get out at the top.
Just bear that in mind when you think that happy days are here again and the champagne starts flowing. There's acid in those bubbles.
Ben Stein
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