WSJ - Markets

Top of the Market? That Could Be a Good Thing

When is it going to end? And how?

In a year when asset prices have surged, those are questions that should be nagging at investors’ minds. Stocks, hardly cheap at 2017’s onset, have gotten progressively more expensive. Prices on junk bonds and emerging-market debt have risen sharply, driving yields even lower.

Do these markets count as bubbles? Probably not. That’s because many of the usual hallmarks of bubbles—euphoric optimism, excessive trading and a belief that no matter how crazy prices are, someone will be crazy enough to pay even more—are absent. If there is euphoric optimism, it is in the prices of Silicon Valley’s unicorns and in impossible-to-value bitcoin which is up more than 700% this year.

Still, an asset doesn’t have to be in a bubble for it to be excessively valued, or for its price to drop. One danger is that, after the dot-com bust and the financial crisis, investors now believe that the only time markets fall sharply are when there is a bubble.

High prices don’t mean the market will fall, though when it does, the selloffs tend to be more intense. A fresh reminder came when a sharp fall in the high-yield bond market this month led investors to pull money out of junk-bond funds at the third-highest pace ever.

By one popular yardstick, U.S. stocks have rarely been so expensive. The cyclically adjusted price earnings ratio devised by Nobel Prize winning economist Robert Shiller has gone to 31.3 from 27.9 this year. That level has only been eclipsed twice: Just before the 1929 crash when the measure peaked at 32.6, and in the years surrounding the dot-com bubble when it reached 44.2.

Mr. Shiller’s measure may be elevated, in part, for technical reasons, which can offer investors some solace, but maybe not too much: The S&P 500 would have to fall by a third for the Shiller PE to decline to its average level over the past half-century.

When markets do fall, they usually fall for a reason. The usual culprits are recessions, falling corporate profits and central banks aggressively pushing up rates. When the Federal Reserve raised rates in the late 1960s, helping to push the U.S. economy into recession, stocks fell sharply. And while the economy weathered rapid rate increases in 1994, it was a trying year for stocks.

At the moment, such risks don’t seem to be in the offing. Rather, the world is in the midst of an unusual moment where countries all over are growing while low inflation is keeping central banks at bay.

Perhaps that is why surveys show investors putting lower-than-usual odds on the chances of stocks crashing. And maybe that is part of why markets are showing so little volatility—if the risk of a big decline seems low, then any little jog down looks like a buying opportunity.

That in itself is a reason to be wary. If investors are almost all confident, there will be a lot of sellers when the environment sours. And if markets don’t pause here—if the benign outlook is justification for pushing valuations even higher—the eventual panic, and losses, will be greater.

Write to Justin Lahart at

Appeared in the November 20, 2017, print edition as ‘No Stock Bubble but Rising Risks.’ Markets

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