The stock market may be pricey, but it’s nothing like the genuine market

Traders wearing masks work inside posts, on the first day of in-person trading since the closure during the outbreak of the coronavirus disease (COVID-19) on the floor at the New York Stock Exchange (NYSE) in New York, U.S., May 26, 2020.

Brendan McDermid | Reuters

Bluster about bubbles is blowing through Wall Street again, stirring investor passions and kicking up enough dust to cloud investors’ view of the market’s message. 

Stocks’ surge off the panicky March lows has been so fast and dramatic alongside an economy only slowly emerging from a pandemic shutdown, that observers have insisted the only explanation is an irrational collective speculative furor pushing asset values away from economic realities, enabled and emboldened by an aggressively easy Federal Reserve.

Last week long-tenured value investor Jeremy Grantham in a CNBC interview called the U.S. stock market a “Real McCoy bubble,” the fourth of his career, citing extreme valuation and rampant speculation in financially sketchy stocks. His danger warning followed those of esteemed hedge-fund managers Stanley Druckenmiller and David Tepper, who likewise compared the current market to the bubbly culmination of the late-’90s stock mania (before partially retracting those calls).

Oaktree Capital founder Howard Marks, a widely followed thinker on markets, released his latest investor letter last week, detailing the factors driving the embrace of risky assets since March and insisting, “fundamentals and valuations appeared to be of limited relevance” in the rally. “In all these ways, optimistic possibilities were given the benefit of the doubt, making the terms ‘melt up’ and ‘buying panic’ seem applicable.”

Near the center of seasoned investors’ alarm over the market action is the recent burst of small amateur trading activity, centered on clients of the zero-commission Robinhood app and the real-time trading commentary of Barstool Sports founder David Portnoy – whose cheeky motto “Stocks only go up” has been embraced by those racing into beat-up travel stocks and, notoriously, the shares of bankrupt car-rental firm Hertz.

There is at least a vein of truth in all these complaints. With the S&P 500 down a mere 8% from its February peak despite a quadrupling of the unemployment rate and collapse in earnings forecasts, stocks have indeed run far ahead of present economic realities in pricing in a sharp rebound.

20-year high valuation

Equities do look pricey, with the S&P at 22-times forecast earnings for the next 12 months, near a 20-year high. The Fed’s vow to keep short-term rates at zero for years and its forceful move to buy corporate bonds have absolutely compressed risk spreads and encouraged investors to accept slim compensation for shouldering credit risk. Investment-grade corporate yields sank under 2.2% last week, which quite directly helps explain stocks’ elevated valuation.

As for the Robinhood, speculative-trading phenomenon, some of it surely seems overheated and lacking in rigor….

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