Creating a bubble is within everyone's reach. To produce one that can hold a little boy, you need only 7 liters of warm water, 500 milliliters of glycerin that can be purchased in pharmacies and half a liter of dish soap. With a little experience, the bubble turns out to be surprisingly stable and malleable. In financial markets, bubbles behave differently. Like the bubbles in boiling water, they start slowly and gradually accelerate until they reach a paroxysmal level. The bursting of financial bubbles does not necessarily happen spectacularly. Usually the climax phase is followed by a cooling period (which can also last a few weeks) during which volumes drop sharply and the trend becomes sideways.
Then, suddenly, the fall begins. The supporters of the thesis of the indefinite rise on the stock exchanges are currently divided into three groups. The first argues that ever-growing earnings give the market the right to rise even if it is at all-time highs. Proponents of this group often shy away from earnings quality, and their critics point out that this year's increases are mostly due to financial engineering (own stock purchases) and a lower tax burden (8 percentage points of corporate tax actually paid compared to before the crisis). After all, with productivity down to zero and revenue growth modest, there aren't many other ways to boost earnings per share. In any case, the proponents of the profit thesis operate within an orthodox theoretical framework. A stock market that rises because profits rise is part of the natural order of the universe.
As for quality, it is normal for there to be a deterioration in the second half of a bull cycle. Of course, with particularly high liquidity still available, the buy-backs are expected to be even more impressive than in the 2006-2008 phase. You may not like it, but it's a fact of life. The second bullish school of thought does not focus on earnings but on multiples. We're at the same price-earnings levels we saw at the top of the previous big hikes (including the internet bubble, if you take tech stocks out of the count), but this time we're dealing with zero Fed Funds interest rates , against 6 percent in 2000 and 2 percent in 2008. Multiples, therefore, have the right to score new highs. The comparison with ten-year rates is even more dramatic. Here the theoretical sphere is borderline between orthodoxy and fantasy. The so-called Fed model, which makes equity multiples descend from the level of rates on long Treasuries is an invention of Ed Yardeni and has never been recognized by the Federal Reserve. Below a certain level of interest rates the model is even weaker. With hypothetically zero-yield XNUMX-year bonds, the multiple of earnings could go infinite, a level that not even the most optimistic dare to predict.
The third bullish school of thought is the one that is most intellectually stimulating at this stage. We are referring to the supporters of the correlation between market performance and investor sentiment. Excited buyers who declare themselves optimistic and buy without paying too much attention to the cost are a clear sign of overheating for this school and pave the way for a downturn. Frightened sellers who rush to get rid of their shares at any price because they believe the end of all things are near are, on the contrary, typically valuable indicators of a near future upside. It happens that the most recent surveys of the mood of American individual investors (individuals, therefore, not professional managers) give only 37 percent optimism against 62 percent in October 2007, corresponding to the all-time high ( 1565 on the SP 500) of the 2003-2008 bull cycle.
The general public is generally more emotional than the institutional ones and it is therefore even more interesting to record their mood changes. Of course, proponents of the sentiment school believe that the stock market has a right to rise until the optimistic rate has risen to at least 62 percent of its previous record. We will see. However, we get the impression, as far as individual investors are concerned, that there has been one of those attitude changes that happen once or twice a century. Whoever was burned by 1929 did not buy any more shares for the rest of his life not even in the United States, the home of mass ownership. Anyone who was in debt in Japan in the 2000s, be it a company or an individual, never asked to borrow a yen after repaying the debt. There are traumas that remain imprinted deep inside and are never resolved. Many managed to weather the Nasdaq crash in XNUMX, but the repetition of the shock eight years later, on a widespread scale and with no escape from any stock sector, convinced a generation to stay away from the stock exchange or, at best, to delegate to a manager the stress of volatility and performance. This is confirmed by the data on flows to equity funds.
From 2009 to early 2013, years in which the share price doubled, there were really only redemptions. It took last year's sharp rise to get the public to put something on the stock market again. There were big headlines in the newspapers, but the phenomenon was short-lived. The latest data available, relating to May of this year, even records a net outflow. If individuals take advantage of the rises to sell and institutional investors remain more or less convinced in the market to produce alpha, who is driving the stock markets up? These are the companies that buy their own shares. The conclusion to be drawn is that waiting for the mass arrival of individual investors and waiting, in order to sell, for the neighbor, the personal trainer and the elderly aunt to start bragging about their stock successes and exchanging tips in the elevator risks being a futile exercise. If they haven't reached a tripled purse maybe we'll have to wait for their children. Since the companies will continue to buy treasury shares in the next two-three years (many buy-back programs have a multi-year duration and have already been approved by the boards of directors), the only person who will eventually be able to change the (bullish) course of things they are the institutional managers.
Those managers who, in these hours, have been told by Yellen that the Fed will not raise rates just to stop the markets and that, if anything, will resort to macro-prudential measures to curb their ardor (stricter regulations, increased initial margins obligation to hold a certain amount of liquidity). Hearing once again that the Fed will not raise rates (except for macro reasons not yet present at the moment) and seeing that no macro-prudential measures are actually taken, what is a manager to conclude from this, other than that the Fed is still smiling at those who buy shares? That's why no one, if not a few private individuals left, is no longer a net seller. That's why managers remain invested without displaying warmth or emotion. That is why stock markets continue to rise at the slow and monotonous pace of share purchases by the treasurers of publicly traded companies. It's a new world out there.
