Pricey. Frothy. Overvalued. Choose your word: They all apply to today's stock market.
But none of that means a serious downturn is looming right now.
There are at least two reasons why this aging bull market is likely to have at least one last gasp in it.
The first is the phenomenon that traders lovingly refer to as TINA – There is No Alternative. So long as bond yields remain miserably low, investors in search of bigger returns have a strong incentive to venture into the stock market.
TINA, to be sure, faces a threat. The market's recent tremors reflect worries that the U.S. Federal Reserve will start raising interest rates sooner than expected, thereby boosting bond yields and providing more competition for stocks.
Vigorous job creation and an unemployment rate now below 6 per cent are encouraging speculation that the Fed could raise rates as early as the first quarter of 2015 to quell potential inflation. That would be several months earlier than investors had been counting on.
However, an early rise is far from a done deal. So far, there is scant evidence of inflationary pressure – in fact, market expectations of future inflation have actually been dropping.
In addition, wage growth has been slow and the jobless rate, at 5.9 per cent, is still above the 5.2 per cent to 5.5 per cent that the Fed would like to see in the long run. Also, the U.S. dollar is rising as a result of Europe's struggles, and a stronger currency should drag inflation lower because it reduces the price of imported goods.
Put it all together and the Fed seems unlikely to rush into action on the inflation-fighting front. As many commentators have pointed out, the risks are asymmetric – if the Fed raises rates too soon, it could cut short a promising recovery, while if it moves too late, the worst danger is a bit of excess inflation that the central bank could stem with further rate hikes.
The emerging U.S. recovery provides a solid second reason to think this bull market still has a bit of room to run. The big job gains reported on Friday underline the brightening state of the world's most powerful economy. Third-quarter corporate earnings, which begin to be reported next week, are expected to show a solid 4.6-per-cent advance.
One of the most optimistic signs is the strong growth in car sales, which are now running at a 16-million-vehicle-a-year pace, similar to pre-recession levels.
Economists Atif Mian and Amir Sufi, authors of House of Debt, a look at the Great Recession, point out that while sales of new vehicles make up only about 3 per cent of GDP, they account for a startlingly large part of its fluctuation. The economists estimate that a decline in new auto sales was responsible for more than a quarter of the peak-to-trough fall in GDP during the downturn following the financial crisis.
Given that, it seems reasonable to conclude that the recent recovery in car sales has added a similar amount of GDP, and there's no reason to think that the stimulating effect will wane any time soon. The average age of light vehicles on the road in the United States is 11.4 years, a record high, according to IHS Automotive. Millions of Americans will soon have no choice but to replace their vehicles.
A stronger economy and a do-nothing Fed shouldn't make investors complacent. Viewed in comparison with their earnings over the past 10 years, stock markets in both the U.S. and Canada seem very pricey. In addition, there's the potential effect from the formal end to the Fed's quantitative easing program.
However, both of those risks have been recognized for a long time, and there's no particular reason to think they should kneecap the market right now. This bull market is more robust than the past week's tremors would suggest.