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3 Reasons to Stop Fearing a Market Bubble

The rhetoric sure seems convincing, but a reality check says the market isn't actually in bubble territory

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The recent onset of the bubble discussion is certainly understandable. The market is up 25% with a month to go in 2013, the average stock’s P/E ratio of around 17 feels a little more frothy than the norm, and the S&P 500 has now rallied for more than two years without a “normal” bull market correction of more than 10%.

Generally speaking, that feels an awful lot like things were in the late ’90s, and how things felt in 2006 and 2007 as well.

The devil is in the details, though. While stocks might be due for a dip, a closer look at the current metrics — and the immeasurable nuances — suggests there isn’t a bubble ripe for the popping just yet. The three best non-bubble arguments include:

Current and Projected Valuations Are Below ‘Peak’ Norms

To give credit where it’s due, it was Charles Schwab strategist Liz Ann Sonders that did the legwork to find out that, while pricey, stocks aren’t valued at unheard-of levels on a trailing or a forward-looking basis.

As it stands right now, the S&P 500 is priced at 17.6 times its trailing income. However, the typical bull market “peak” P/E reading (going back more than 60 years) is 18.7. The 2007 peak was a tad lower, at 17.5, so that could ring mental alarm bells. But, it’s not unusual to see the market’s P/E ratio reach the very high teens or the low 20s from time to time.

The forward-looking P/E ratio of 15.9 right now is even more encouraging vs. the normal forward P/E measures seen at bull market peaks. The average projected P/E at market tops is 18.1. The forward-looking ratio when the market peaked in October 2007 was 22.4, and the forward-looking P/E measure when the S&P 500 was topping out March 2000 was a dizzying 27.2.

At this time, earnings still are catching up to the market’s price, while profits typically are stagnant or waning at real market tops.

The Economy Is Mediocre — at Best

You can point to several different clues: low inflation, tepid employment, mediocre GDP growth. They all say the same thing — this isn’t an economy being driven by demand for want-to-have things, but rather, an economy being propped up by have-to-have things. (Apple products have been shoved out of the latter category into the former.)

So how does that make our current situation not bubble-esque?

Because nearly every bubble we’ve seen pop during the modern economic era was popped because the consumption of goods outpaced their production, and that consumption was driven by leverage (credit) in one form or another that surpassed the means to service that debt. Yes, this means stocks as much as it means iPads or cars or houses.

Although sales of everything are still on the mend from the 2008-09 lull, we’re nowhere near as consumption-crazy as we were then … at least not yet. We are pointing in that direction, however. It might be another couple of years before we start to borrow against anything to buy, well, anything else.

The bubble will be marked by demand driving inflation back toward 3% vs. the current annualized inflation rate of less than 1%, which will likely only happen if we can pull the unemployment rate beneath 5%.

That’s when you should start getting worried.

Article printed from InvestorPlace Media,

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