Is Stock Market Swoon the Bursting of a Bubble?

With the dramatic plunge in US stocks of 10% (as of Tuesday’s intra-day low), investors are asking whether this is just a normal “correction,” or has the nearly nine-year bull market finally come to an end? No one knows the answer, of course.

I argued in my Blog on January 11 and my E-Letter on January 16 that US stocks were extremely overvalued, and that the next correction would likely be quite severe. You might go back and take a look at those selected comments, as they were right on.

Yet the issue we have to face now is whether the implosion of the US stock market in less than a week is the beginning of a new bear market (the bursting of a bubble) or merely a much-overdue downward correction that will be followed by new record highs in the weeks or months ahead.

A column earlier this week by one of my favorite writers, Mark Hulbert, makes the case that the latest bust in stocks is NOT the bursting of a bubble. Mark is the editor of the long-running Hulbert Financial Digest which tracks the performance of many investment newsletters.

It is rare that I disagree with Mark, but this is one such occasion. Mark argues that the latest market implosion is not a bubble bursting and, as always, offers some convincing stats. Here are a couple.

Low Number of IPOS: Mark points out that Initial Public Offerings (IPOs) were rampant in 1999 at 477 just before the Internet bubble popped, whereas in 2017, there were only 108 IPOS. Good point.

Low first-day gains in IPOs: Along this line, Mark points out that in 1999, the first-day return on new IPO stocks averaged 57%; in 2017 the average first-day return was only 15%. Another point to suggest we’re not in a bubble.

Hulbert goes on to site several other indicators which suggest the stock markets are not in a bubble today, but they are too complicated to go into in this limited space. You can read them here, if you like.

Yet one can argue that the US stock markets have indeed been in a bubble since late last year. A picture (chart in this case) speaks a thousand words, as the saying goes.

The Dow rose over 28% in 2017 following a 16.5% advance in 2016. It was up over 40% just since President Trump was elected, versus its historical annual average of about 7%. That qualifies as a bubble to me. And the massive decline we have seen over the last few days has also been historic in that Tuesday’s 1,175-point single-day plunge was the worst on record.

Again, this could qualify as the bursting of a bubble, if you ask me. Now, let me put that in perspective. Despite how ugly the chart above looks, the lows on Tuesday only represent a correction of apprx. 10% from the high at the end of January. A 10% correction is certainly not insurmountable.

The stock markets will almost certainly mount a retest of the January highs at some point. The question is now, is there enough pent-up buying power to push these markets to new record highs. Most Wall Street forecasters say there is. But let’s face it, they always say that.

Time will tell. Yet I will not rule out the possibility that the bubble has been burst, and we have seen the end of the greatest bull market in most of our lifetimes. I readily admit I could be wrong. Then again, maybe I’m not…

Finally, the Senate announced a massive two-year budget deal yesterday which could prevent a government shutdown at midnight tonight. The plan still must be voted on today in the Senate and then go to the House where it faces strong headwinds.

The new budget, if it passes, would boost military and non-defense spending by more than $300 billion over the next two years. About $160 billion would go to the Pentagon, about $128 billion would go to non-defense programs and more than $80 billion would go to disaster relief.

This is just another government spending boondoggle in my opinion that will only add much more to the budget deficit over the next two years. It will also mean raising the debt ceiling. It remains to be seen if the House will pass it to avoid another government shutdown.

The stock markets are sharply lower again this morning, as this is written.

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