“Dear David, What is your opinion on this article [from The Guardian] that claims that there is a "bubble" in the USA and UK stock markets?”

 Ed: Here is the opening:

 According to the stock market, the UK economy is in a boom. Not just any old boom, but a historic one. On 28 October 2013, the FTSE 100 index hit 6,734, breaching the level achieved at the height of the economic boom before the 2008 global financial crisis (that was 6,730, recorded in October 2007).

Since then, it has had ups and downs, but on 21 February 2014 the FTSE 100 climbed to a new height of 6,838. At this rate, it may soon surpass the highest ever level reached since the index began in 1984 – that was 6,930, recorded in December 1999, during the heady days of the dotcom bubble.

The current levels of share prices are extraordinary considering the UK economy has not yet recovered the ground lost since the 2008 crash; per capita income in the UK today is still lower than it was in 2007. And let us not forget that share prices back in 2007 were themselves definitely in bubble territory of the first order.

The situation is even more worrying in the US. In March 2013, the Standard & Poor 500 stock market index reached the highest ever level, surpassing the 2007 peak (which was higher than the peak during the dotcom boom), despite the fact that the country's per capita income had not yet recovered to its 2007 level. Since then, the index has risen about 20%, although the US per capita income has not increased even by 2% during the same period. This is definitely the biggest stock market bubble in modern history.

David Fuller's view

Here is The Guardian article: This is no recovery, this is a bubble – and it will burst.

This is a generally good article although the author seems to think that the stock market should reflect the economy.  It will reflect monetary conditions but most UK and USA companies are considerably better off than their respective home economies, as I have mentioned before. 

For instance, they do not face the same debts or employment problems.  They can also earn revenue beyond their home shores, and some companies listed in the UK are not domiciled here.  However, all these shares have definitely benefited from technology enhancements, low interest rates and quantitative easing (QE).  

The UK’s FTSE 100 Index is not cheap at a trailing p/e of 17.59, although the yield is still reasonably favourable at 3.99%, according to Bloomberg.  This is more attractive than the USA’s S&P 500 Index which has a slightly lower p/e of 17.04 but yields only 1.94%.  Moreover, the fashionable Nasdaq Composite Index is clearly expensive with p/e of 31.42 and a yield of only 1.23%.  This has bubble characteristics, as I have been pointing out recently, although not to the extent that we saw in 1999/2000. 

In less difficult economic times central banks ‘remove the punchbowl’ when markets and the economy overheat, by raising interest rates.  That may not happen for a while in the UK or USA, given the severity of the credit crisis recession and the need for stronger, self-sustaining GDP growth.  Consequently, somewhat expensive markets, not to mention a number of high-flying tech shares could become more obvious bubbles. 

We need to be alert to this risk and not buy the hype of better controls, safer environments and lower risks than in the past.  Some things never change, including greed and fear.

Meanwhile, I think it is good that some markets have recovered since the bearish January effect.  It suggests that we may see more of the choppy ranging, in line with Fuller Treacy Money’s view, than significant downward spirals.  We need several years of market ranging in order for valuations to improve.  However, developed markets still have the monetary tailwinds so further overvaluations would increase risks.  This remains a buy-low-sell-high environment.