Stock Markets in their Third Bubble Since 2000

Published by Philippe Herlin | Aug 28, 2014 | Articles

The S&P 500 just passed the 2,000-point psychological threshold, an absolute record for that index, created in 1950 and comprising the 500 largest companies traded on the U.S. stock market, thus being more representative than the famous Dow Jones Industrial Index, with its 30 companies. This new record would seem to show that the U.S. recovery is under way... but let’s step back a little in order to evaluate these numbers.

As can be seen on this 1950-end of 2013 graph (reaching 1,600 points), the S&P 500 has been quite erratic since the 2000s, with two bubbles that burst! But let’s get back to the ‘80s... Back then was the triumph of Ronald Reagan’s “conservative revolution”, which led to a vast liberalisation of the economy with whole sectors being allowed to compete (air transportation and telecoms, notably), while at the same time income tax was reduced, thus encouraging wealth creation. Sound growth takes place and the United States comes out of the ‘70s crisis on the way to two wealth producing decades.

In all logic, the S&P 500 starts to rise in 1982, with the 1987 October crash being just a glitch quickly forgotten. But, starting in 1995, the trend picks up, with the start of the “internet bubble”. Much hope is placed in the nascent network and heads are spinning a little too much. The bubble burst, beginning of 2000, and the S&P 500 went from a peak of 1,527 to a trough of 800 in 2002, almost down by half. And the September 11 attacks added to the ambient dire straits. That is when Alan Greenspan decided, in order to sustain economic activity, to lower the Fed’s base interest rate... a lethal mistake! Growth did make a comeback, but it was on the back of housing starts and the infamous subprimes, a pure credit bubble. The rest is history: the S&P 500, again, went from a peak of 1,561 in 2007 to a trough of 683 in March, 2009.

Why has the S&P 500 been rising since March, 2009? Has growth made a comeback? Barely... The only thing that can explain it is the Fed’s QE plans that began at that time. Since then, the index has been progressing at the same rate as with the two former bubbles, which is both revealing and worrisome. There is no sound growth in the economy that could justify such a progression: from one quarter to another, GDP variations are hesitant, with a trend around 2%. Not what one can call a recovery in the United States. The lower unemployment rate is due, essentially, to long-term workers leaving the work force, as shown by the decline in the number of people looking for work in the statistics.

All the signs are pointing to a third stock market bubble, albeit much bigger than the other two (at least 2,000 points, compared to 1,561 in 2007 and 1,527 in 2000)... why? The “fuel” for the first stock market bubble was an outsized belief in the disruptive nature of the internet (which, finally, will have taken more time to get set); the “fuel” for the second bubble was real estate credit to individuals, a large portion of bank credit. The “fuel” for our actual bubble is much more powerful, since it is the United States central bank, the Fed, with its QE plans (buying Treasuries) and its base rate near zero, already having been going on for four years. This lax policy should soon end, according to the Fed’s chairwoman, Janet Yellen. We shall see... but the fall may hurt quite a bit.


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Philippe Herlin  Finance Researcher / Member of the Goldbroker.com Editorial Team

   

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