Stocks Aren't At Record Highs, Even If It Mattered
The big finance news this morning was that the S&P 500 topped 2,000 for the first time ever. The exuberance was palpable, but it was also irrational.
The S&P is a leading indicator of equities, but there is nothing special about breaking through a ceiling of 2,000. Besides being a nice round number, it holds just as much (or little) importance as 1,976 or 2,014. But because it is a round number, Reuters, CNN, and CNBC squeezed a morning's worth of airtime out of it.
That's not the only reason that this morning's record high doesn't matter; the S&P 500 is not adjusted for inflation, meaning that we're comparing 2014 dollars to 1999 or 1963 dollars. To give you an idea of what today's "record high" looks like compared apples-to-apples with the past 30 years, I put together this graph:
The real value of the S&P 500 topped out in August 2000 just before the Dot Com Bubble burst, when it was 2,090 (in 2014 dollars). That might not leave investors with much confidence that the market will stay on an upward trajectory for much longer or, worse yet, may even be headed for a crash. Those investors may be doubly and triply concerned when considering that the Fed will raise interest rates in the next year (which could lead to an outflow from equities back to bonds) and CAPE ratios are their highest level outside of 1929, 1999, and 2007. Just look at this graph from Nobel Laureate Robert Schiller's Irrational Exuberance:
Source: Robert Schiller
But I remain unconvinced by warnings of a new market crash. For one, market observers have a record of predicting 9 out of 5 recessions. Beyond that, markets don't crash when the economy is getting better. More jobs, more spending, better earnings. With better earnings, CAPE ratios drop and investors buy the good deals.
More importantly, equity prices have risen so much due to constrained supply. 2014 is already the largest year for stock buybacks in history. By limiting the supply of shares, the prices naturally move higher than they would have been, making those high CAPE ratios look more reasonable. The trend of buybacks is disappointing, however. Companies sitting on a lot of cash have made the decision that their EPS be better if they invest that cash in shrinking the number of shares outstanding instead of investing in new projects to raise revenue. Perhaps this is a testament to the pressure on CEOs and CFOs to deliver immediate results rather than build long-term earnings trajectories.
Either way, these buybacks are the reason the S&P 500 hit a meaningless not-record-high, rather than there being an impending crash on the way.