I read this on the social media, so it has to be either true… or fake:
The S&P 500, Dow, Nasdaq Composite and Russell 2000 all closed at records today. Last time that happened was Dec. 31, 1999.
— Callie Bost (@callieabost) November 21, 2016
Let’s assume that it is true for a moment. For those of us who were active in financial markets in 1999, it’s hard to forget the unbridled economic optimism at the time. It was all out euphoria for the technological renaissance that was upon us, with a sprinkle of apprehension that it could all come tumbling down as clocks hit midnight on Y2K and dates buried deep within code thought it was the early 1900’s. (Google it kids).
The poster-child for this market exuberance was the Nasdaq Composite whose opening tick of 1999 was the low for the year at 2207, and who’s close of the year at 4069, was a few ticks away from its all time high, and 85% higher than its Dec 31, 1998 close of 2192! This is what the largest financial mania (by size) in the history of the world looks like:
And when said bubble burst in March of 2000, it took years to work off the excesses, shedding nearly 80% in value to its lows in Oct 2002 (three consecutive annual losses from 2000 to 2002… -39%, -21% & -31.5%), massively overshooting the 1999 range to the downside:
The term bubble has been assigned to a few markets and risk assets over the last 5 years. Most of the time it has been used by critics of the Fed’s monetary policy. The Fed has expanded their balance sheet by trillions of dollars through their purchase of bonds. This is an effort to suppress interest rates to spur lending, stimulate employment and stoke inflation. It’s also intended to stimulate demand for risk assets by creating a wealth effect for owners, with… the rest trickling down.
With equity markets at all time highs, they could be forgiven for raising the Mission Accomplished banner. But 8 years on from the worst financial crisis since the Great Depression, the Fed is now just seeing the full signs of mandate success, with unemployment back to pre-crisis levels and inflation starting to tick up.
The enthusiasm for stocks since the election is based on an assumption that all of the promises of the campaign having to do with protectionism, trade wars, military alliance and trade deal withdrawals were just a con for votes in the Rust Belt. And the traditional Republican platforms like tax cuts, de-regulation of banks, oil and gas, healthcare and a repeal of employee protections will be put into effect. Sprinkle in a bit of stimulus with a promise of a trillion dollar infrastructure spending, financed by near zero interest rates, and no regard for the deficit/ national debt (tax cuts + stimulus spending = massive deficit) and you have the same sort of “I’ll just make sure I’m not the last guy holding the bag” attitude that you saw in the waning days of the 90’s.
Let me be clear, I just mean the mood and the level of trust that we won’t get burned. While valuations seems stretched by traditional measures, they are nowhere like they were in 1999/2000. The bubble is merely in optimism.
I’ll make two other points. First, let’s not forget that despite the sharp rise in sovereign yields from the July lows, the Fed Fund rate and the 10 year Treasury yield were above 6% when the Nasdaq was at its highs in 2000, and they were both just above 5% at the 2007 highs:
Lastly, and kind of importantly, the Nasdaq Composite is 3% from its mid 2015 then all time high, 3%! Maybe just maybe its about to make a parabolic run out of that might be viewed as a two year consolidation (4200-ish to 5200-ish):
Your guess is as good as mine as to what comes next but it is important to remember that the bubble in enthusiasm of late might be predicated on similar emotions to risk asset bubbles past. There’s an assumption that the President elect is a traditional Republican who just wants to build some roads and some airports to satisfy his populist promise.
And that may be true to some extent. This hodge podge of economic policies could be a quick high, with hangovers down the road. Maybe the Republican House looks the other way at a deficit expanding stimulus because they’re getting de-regulation and deficit expanding tax cuts. And in that case, with unemployment below 5%, the labor market tightening and income finally rising, that may be the elixir to those economic problems holding us back from a parabolic move in GDP.
But let’s not forget that that combination of the economic policies will lead to a dramatic increase in our deficit, while interest rates and the U.S. dollar are rising. That could end up being the very headwind to the economic growth that U.S. stocks are currently betting on. Conditions are very different than the hyperspace drive we went into in the 90’s. But the optimism is starting to feel the same. And if history tells us anything, the higher we go now, the greater the potential overshoot on the way back down.