2 important things to remember about bubbles and all-time highs

The S&P 500 has been surfing an all-time high of late, cresting above 4,200, though it’s down around 2% to around 4,130 after a small sell-off. The strong market and inflationary concerns are causing some fear about an overheated economy — and some people are breaking out the “b” word. (“Bubble.”)

But according to analyst after analyst, there are reasons to be bullish about the future, and that maybe investors shouldn’t worry so much about bubbles.

Investors are notorious for sitting out market turbulence only to wait too long, letting big gains pass them by in an attempt to time the market. Doubtless there are many people who pulled money out in March 2020 who are waiting to get back in. That position isn’t hard to understand, of course: The market was roaring as the pandemic raged, which many saw as illogical so didn’t invest.

But the market is about the future, and earnings have exceeded expectations, pushing stocks higher. The all-time highs last summer were just the market pricing in the future before it arrived. (It did arrive.)

This may sound like the market is getting out over its skis, with valuations reaching past fundamentals. And you wouldn’t be wrong if you thought “expensive markets,” as JPMorgan calls them, sounded bubbelicious.

That’s because “bull markets and bubbles are indistinguishable ex ante,” JPMorgan analysts wrote in a recent research note. “Both begin with a compelling narrative that eventually leads analysts to discard previous valuation yardsticks because ‘this time is different.’”

The most important thing to remember about all-time highs

The most important thing for investors to remember about all-time highs is they’re often a step on the way to another all-time high. Right now, the S&P 500 at 4,200 might seem crazy high but so did 4,000. And 3,000. And 2,000. A quick look at a Yahoo Finance chart will show plenty of teeth as the market had its ups and downs but also many ramps.

According to JPMorgan, this even happens in “expensive markets” across asset classes, “though more in equities, commodities, and currencies than in bonds or credit.”

Though they may crash and be down for months or even years, “80% of expensive markets that crash spectacularly eventually make new all-time highs.”

“This last point challenges the notion that bubbles are prevalent at the asset class level,” the analysts wrote. “Perhaps instead, mostly-rational markets simply front-load a macroeconomic scenario that will be validated in the following cycle.”

Looking back at last year, that’s exactly what happened — multiple times. When Covid hit, the market plunged; the S&P 500 index fell more than 30%, and saw multiple days of 5% drops or more. And later in the summer, the market was roaring past all-time highs far before earnings had improved or the pandemic had eased. (In fact, it was getting worse.)

More room to run

The conversation about all-time highs begetting more all-time highs is nice in the abstract, but what about the actual economic and market conditions in this specific market? A lot of the analysis seems positive based on the data coming in.

“With business owners eager to hire and with the Labor Department’s JOLTS index showing around 7,000,000 unfilled job postings from businesses it would seem realistic at this juncture to venture that there’s plenty of opportunity for things to continue to improve,” Oppenheimer analysts wrote in a note this week.

Oppenheimer pointed out that earnings are up 47.2% on revenue growth of 10.1% for the 88% of companies that have reported, exceeding expectations.

DataTrek’s Nicholas Colas believes that analysts are aiming too low still.

“We believe analysts are still too low with their estimates for Q2 and the rest of 2021,” he wrote. “Despite the fact that Q2 earnings are typically just as good as Q1, the Street is looking for the current quarter to come in 9% below Q1 2021. Ditto for Q3, by the way. Why? We’ll chalk it up to a lack of corporate earnings guidance and a resultant conservatism among analysts.”

“This is still a bullish setup for US large cap stocks,” Colas added.

This conservatism could go away with more guidance and the rest of the earnings season, but already BMO’s Brian Belski has bumped up his S&P 500 EPS target for 2021 from $175 to $190, an 8.6% increase.

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Ethan Wolff-Mann is a writer at Yahoo Finance focusing on consumer issues, personal finance, retail, airlines, and more. Follow him on Twitter @ewolffmann.

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