A frothy market misses vital bubble ingredients

(Illustration: Alexandra Citrin-Safadi/WSJ)
(Illustration: Alexandra Citrin-Safadi/WSJ)


Measures of investor sentiment are positive, but nothing like past bubbles.

Stocks are expensive, they’ve gone up a lot in a very short time and investors are excited. Not surprisingly, talk of bubbles is widespread. But many of the usual accompaniments to a bubble are missing.

The case for stocks being frothy isn’t hard to make. The Nasdaq hit a new high on Thursday, having risen 54% since the start of last year, while the S&P 500 is up 32% and Nvidia’s gains are so big they’re better expressed as the $1.5 trillion it has risen in value than as the hard-to-grasp 441%. In a single day last month, it rose in value by $276 billion, about the value of Chevron, the 26th-largest member of the index. This isn’t normal behavior.

But is it a bubble? There’s no single definition of a market bubble, but for me it has to involve a speculative mania. It’s when buyers en masse cross the line from assessing future profit potential to buying something they know is unreasonably expensive—or just don’t care about the price at all—because they think a greater fool will buy it off them at an even higher price.

This seems to be missing. Sure, there are some signs of the madness of crowds: The price of SoundHound AI more than tripled in February, mainly because investors were reminded that Nvidia, maker of the chips in demand for artificial intelligence processing, owned a tiny stake. And sure, minuscule stocks are doing phenomenally well, as they often do in a bubble, with the Russell Microcap index up almost 30% in four months, one of its best performances on record.

But compared with the post-pandemic silliness in meme stocks, profitless tech, SPACs and crypto, or the dot-com bubble of the late 1990s, this pales into insignificance. Measures of investor sentiment show they are positive, but nothing like past bubbles. One example: The weekly survey by the American Association of Individual Investors shows 47% declare themselves bullish, low compared with the 75% declaring themselves bullish in 2000, or even the 60% in early 2018.

Money isn’t flooding into the market, leverage isn’t being used to boost investments, and so companies aren’t forming especially to tap a gusher of speculative cash. Stocks might be overvalued, investors might be wearing rose-tinted spectacles, but that doesn’t make it a bubble. Yet.

Look at both the price gains and valuations.

Sure, stocks are up a lot. But this often happens after a big fall. The point of the Nasdaq making a new high is that it’s only just passed where it was at the end of 2021, before it fell 36%. The same happened after the price plunges of the mid-1970s, early 1980s, 1990, 2001 and the financial crisis of 2008-2009—only with larger gains than have happened so far this time. Such rebounds were clearly distinct from the bubble of 1999, which led the Nasdaq to gain 154% in the same length of time it’s taken to make 54% this time, or 2021, when the gain was 100%, both with a much smaller fall beforehand.

Likewise microcap stocks. They aren’t even close to making back their near-halving from the early 2021 bubble, and still below where they stood last February.

Valuations don’t suggest a lot of speculative buying, either. The Nasdaq peaked at over 100 times predicted earnings for 12 months ahead in the late-1990s dot-com bubble because buyers didn’t think valuations mattered any more.

At the moment the Nasdaq’s at 27 times forecast earnings, much lower than the 35 times it traded at in late 2020. Nvidia’s stunning rise hasn’t been about higher valuations, either—its profits and forecast profits have been rising faster than the share price, so it trades at a lower valuation than before the AI boom started with the release of ChatGPT.

The great bubbles of the past were quite different, involving massive speculation driving up valuations (Japan’s entire market traded at 50 times forward earnings at its 1989 peak). At the extreme, wild optimism turned into the purest form of speculation. Stocks became no more than gambling chips used in a pure Ponzi scheme of selling to a new buyer.

Stock promoters also raced to create new companies to satisfy the demand from buyers desperate to buy into the fashionable story. In all the big bubbles booming stock prices were accompanied by an IPO boom, perhaps taken to the extreme in the 1720 South Sea bubble. Gullible buyers were tempted by new companies raising cash for projects including ships full of water to carry live fish (the fish died); a flintlock machine gun that fired square bullets (too unreliable); and extracting saltpeter from waste collected from lavatories in England, according to historian Edward Chancellor’s “Devil Take the Hindmost."

The 2020-21 SPAC boom was the modern equivalent. But today the IPO market is struggling.

There was a mini-bubble in AI last year after ChatGPT was released. But that shows the difference between speculation based on hope—common as new technologies take off, from canals, railways and bicycles to the internet, solar power and electric cars—and the somewhat more sober situation today. Stocks with any connection to AI soared, before crashing back to earth if they couldn’t show profits to justify the price. Only in the past couple of weeks have some of those same stocks picked up again.

Investors might, of course, be too optimistic about the long-run potential of AI. They might also be wrong about the earnings potential. But given the vast profits already flowing to Nvidia, this is more likely to be the common mistake of failing to factor in new competitors attracted by the high margins on its microchips than outright bubble behavior. At least for now.

Write to James Mackintosh at james.mackintosh@wsj.com

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