This is The Takeaway from today’s Morning Brief, which you can sign up to receive in your inbox every morning along with:
The model of a bubble implies a crash. Just as metaphors of frothiness indicate unsustainable price increases. Sure, portfolios are growing, that’s easy to see for those locked into the daily gyrations of the market or brave enough to take a look at their retirement funds. But what about all the concerned looking over our shoulders investors are doing, wondering when something will snatch the AI gains away?
By a host of measures, stocks are trading at levels that suggest the neighbors have already called the police and the cul-de-sac rager is about to be broken up. Price-to-earnings ratios echo the dot-com era. And buying assets at these prices can feel like a mistake because the dynamics feel untenable. FOMO has a powerful pull, but so does plain old risk avoidance.
Still, people are buying, and the mood in many quarters is bullish. The stock market’s impressive returns and promise for more are in conflict with other signs that overconfidence is leading investors astray.
But there’s a way to think through that tension without confirming belief in a bubble or denying that investors are churning in froth. What if the historical paradigms we use to gauge levels of confidence, market fundamentals, and asset prices are no longer suited to the current environment? That what we see as frothiness and a prelude to a bursting bubble in the benchmark S&P 500 is a new baseline.
“The index has changed significantly from the 80s, 90s and 2000s,” wrote Bank of America analysts led by Savita Subramanian in a note Wednesday, putting that question to clients. “Perhaps we should anchor to today’s multiples as the new normal rather than expecting mean reversion to a bygone era.”
While the S&P 500 trades at statistically expensive levels, the analysts outline the case for why the index merits a premium. The S&P has a lower debt-to-equity ratio than in prior decades; earnings volatility has decreased; and major companies have fewer assets, labor needs, and lower fixed costs, the analysts said. And further efficiency gains can come from AI and deregulation.
In other words, the reason isn’t just pure animal spirits.
Investors are paying up for predictability and safety. And the many ways the index has changed from earlier periods suggest that the higher multiples are warranted.
The reordering of the global economy and a new era of monetary policy also support more durable growth, the analysts argued.
Take the turn away from offshoring. Multinational corporations, for decades, relied on the lower costs of overseas manufacturing and labor to drive growth. Now, following COVID supply chain disruptions and trade conflicts, the shift back to domestic operations calls for heightened efficiency to deal with higher costs. “Growth may be less dramatic, but is likely more durable,” the analysts wrote.
And while the zero interest rate era is behind us, the Fed moving toward a neutral policy is designed to boost what is already a broadening and acceleration of corporate profits.
Compared to prior eras, the historical parallels suggest Wall Street is teetering on the edge. But the risks have changed, perhaps for the better, alongside prices that seem so big, but are more fitting for the moment.
Hamza Shaban is a reporter for Yahoo Finance covering markets and the economy. Follow Hamza on X @hshaban.
Click here for in-depth analysis of the latest stock market news and events moving stock prices
Read the latest financial and business news from Yahoo Finance