After historic gains, are stocks nearing a bubble?

Associated Press

Federal Reserve Chairman Ben Bernanke fielded the usual questions about inflation, tax cuts and government debt during a trip to Congress last week. Then a new question popped up: Is the Fed creating another bubble in stock prices?

Bernanke told the Senate Banking Committee he saw “little evidence” that was happening. But he cautioned: “Of course, nobody can know for sure.”

That’s the problem with bubbles. You only know you’re in one when it pops.

This week is the second anniversary of the bull market that followed the financial meltdown. The Standard & Poor’s 500-stock index is in its fastest climb since 1955, doubling since the market bottomed March 9, 2009. In January and February alone, it’s up 5.5 percent, the best start to a year since 1998.

Stock bubbles are hard to define. In 1999, investors thought it was perfectly rational to pay 62 times a company’s earnings per share for a technology stock because it seemed dot-com companies couldn’t lose. They only realized their error when many of those companies turned out to be slick marketing ploys.

After two bubbles in the past 10 years — tech stocks and real estate — investors are suspicious of consistent gains that seem too good to be true. Some worry that the Fed’s dramatic measures to pump up the economy mean the market’s gains are an illusion. But a range of measurements suggest the market isn’t in the midst of a bubble. Instead, the stock market may simply be back to normal.

“The last two years were the great giveaway,” says Stephen Lieber, chief investment officer at Alpine Mutual Funds. Stocks had fallen so low in the panic that anyone who bought stocks March 9, 2009, got a once-in-a-lifetime deal, he says.

One sign of a bubble would be if stocks rose far beyond what’s normal by historical standards, says Bill Stone, chief investment strategist at PNC Asset Management Group. By that measure, it’s not happening yet. According to Stone’s research, since 1928, the average bull market runs almost five years and gains 164 percent. By comparison, this bull market has barely hit middle age.

The fundamentals of the stock market don’t suggest a bubble, either. The S&P 500 index trades at 17.4 times the earnings of its stocks over the past year. In March 1999, the multiple was 30.6.