Asset Bubbles and Economic Expansions
A lot of comparisons are being made between today's market and the market just prior to the 2000 Tech Crash and the 2008 Financial Crisis. We're not convinced that is accurate. While there are some common issues, there are also many other differences. Let's attempt a compare and contrast as we head into the Memorial Day weekend.
Compare & Contrast - Economy. If we look back in time, primarily at 1999 and 2007 - years just preceding the previous two bear markets - we can get at least some picture of what the market and economic conditions looked at then versus now.
The valuations on the S&P 500 looked similar in 1999 compared to today. However, the valuation looked somewhat normal in 2007, just before the Financial Crisis. GDP in '99 & '07 were more elevated then versus today. Inflation is more elevated today versus the previous two periods in question. However, prior to this year, inflation was running in-line with '99 & '07. We are coming out of a unique recession where most business functions stopped and restarted - not the typical recession. The yield on the 10-year Treasury bond, while higher year-over-year, is still much lower when compared to '99 & '07. Household Debt Service (debt payments as a % of disposable income) looks much healthier today than in the two previous periods. The Fed Funds (discount rate) is more attractive for stocks than in '99 & '07. Housing, which is certainly an asset bubble to watch out for (more on that in a minute), but still lower than '99. Unemployment clearly shows we are not at the full-employment levels of '99 & '07. Wage Growth is rather paltry compared to the previous two periods. Lastly, Consumers are not exactly euphoric like they were in '99 & '07. So, when we step back from the trees to see the forest, the comparisons are not exactly all there to suggest we're on the cusp of a bubble bursting.
If we compare and contrast our favorite benchmarks - the National Financial Conditions Index and the Financial Stress Index (maintained by the Chicago and St. Louis Federal Reserve Banks, respectively), we get a similar picture.
In 1999, just prior to the Tech Bubble bursting, the Financial Stress Index was giving a warning signal by moving above zero. In 2007, both indices were providing a warning as both indices were positive. Today, that's not the case. Both indices are well below zero and have been so for at least the last 12 months. The reality is that we would likely still be in a major economic expansion had the pandemic not occurred and we are just now starting to see what the economy can do as vaccinations have reached acceptable levels and states are re-opening.
Compare & Contrast - Market. If we look at market movement leading up to the two previous bear markets versus today, we also see differences. In both 1999 and 2007, the S&P 500 traded much more choppy than what we are seeing today. When markets are near their peak, news items can tend to cause more havoc than during normal market conditions. For example, in 1999, investors were faced with the impeachment trial of President Clinton (Jan 7th), war erupted in Kosovo (March 24th), and the Y2K Bug was a concern from October of 1999 until the end of the year with the approach of the millennium. In 2007, we were dealing with the surge of troops in Iraq (Feb 7th), the minimum wage increased from $5.15/hr to $5.85 (July 24th), and hearings take place in the House & Senate on the firings of several U.S. attorneys (July 25th).
Below are the charts for the S&P 500 Index for 1999, 2007, and 2021. The chart for 2007 stops at the peak of the market just prior to the Financial Crisis inception. The chart for this year is incomplete due to the fact that we're only through May this year. In the case of 1999 & 2007, the market traded lower and ultimately exceeded the 50-day moving average (blue line). In some cases (twice in '99 and four times in '07), the Index moved below its 200-day moving average (red line). This year, you will notice that is not the case. We've had some news items of note this year, but you will notice the market has been fairly methodical. Every time the Index has reached the 50-day moving average, it has responded by moving higher.
S&P 500: 1999
S&P 500: 2007
S&P 500: 2021
While there are some asset bubbles in today's market environment, we're not convinced they are the same as previous periods. Housing for example is not running higher due to unreasonable demand outstripping reasonable supply - as was the case in 2007. Instead, there is a lack of supply of available housing on the market. During the pandemic people chose to fix up their home and are doing so now because home prices have exceeding reasonable levels. Eventually, demand will slow down to match supply. Digital Currencies have exploded and certainly represent elevated prices, but, Bitcoin, for example, has come off 34% from recent highs set in March. Technology stocks that were the darlings of the pandemic have receded 3% from the peak in April and the market is shifting to value names. Overall, the market activity looks healthy when compared to '99 & '07.