I heard a story last week that summed up the whole mess
Wilbur Ross, a self made billionaire and his son were playing golf a few weeks ago. As the finished up, their caddy approached them and wondered if he could ask them a personal finance question.
"Sure" Ross replied
"I bought 5 condo's in Scottsdale, Arizona," said the caddy "I was able to flip the first 3 but I am stuck with the last two. Should I keep making the payments on them or just walk away"?
Ross thought about it for a minute and asked "Well, were are they? Is the area nice? What else is around the complex that may be of eventual value"?
"I do not know" the caddy replied, "I've never been to Arizona"
That, is a nice neat summation of what a "bubble" in a market looks like. When your caddy thinks he is Donald Trump, it is time to take a close look at what is going on.
I remember back at the turn of the century even your barber or your wife's hairdresser were day trading tech stocks and talking about what they were going to do with the 100% they would make that year. Folks who could not tell you what a PE ratio was were spouting off facts and figures about the latest startup that was going to make them millions. Of course it didn't and they, well, are still the barber and hairdresser and not even thinking about buying stocks today. Now before the barbers and hairdressers who do successfully invest email me, relax. I think we all know what I mean.
I guess if you had to try and define a bubble you could say that it is "the absence of the thought of the probability of loss". When there is a bubble like environment, the thought that an investment decision will not be profitable escapes those investing in it.
Fortunately, for those investing today in US equities, that lack of doubt is not only there, it seems to be prevalent. This acts a constant check on the enthusiasm of the markets participants and help prevent the events of 2000-2001 in stocks and the current situation in housing. In fact, one could argue that there is too much doubt in equities today and that is probably due to the myopic focus we have on our own economy.
Over 50% of the total earnings of the S&P 500 come from international operations. That provides a great buffer against a US slowdown. Will it prevent losses? Surely not. But, it will dramatically lessen the chances of another late 1970's type bear market. It also means that if conditions do deteriorate to the point that we may enter that type of market, it will have been due to a global recession and if that is the case, all investments of all types will suffer.
What does it all mean? Even though we are at near record levels on the Dow and the S&P, we are by no means in another bubble or soon due for a dramatic fall. Currently the S&P trades at a discount to its historical PE, GDP growth, while slowing is still strong, earnings growth is still good and unemployment is still almost non existent. In fact, I would have to argue that one would need to become rather creative to come to the conclusion that a recession or worse is on the horizon.
What to do? Invest. There are bargains to be had out there, just look close and be patient.