Markets in a bubble state is difficult to conclude - column

By Rizza Sta. Ana

Dec 06, 2013 12:44 PM EST

A recent column by money manager and former professional market strategist Barry Ritholtz on Bloomberg detailed points regarding analysts' conclusion of some financial markets experiencing a bubble. Referring to AQR Capital Management founder and quant analyst Clifford Asness' recent list published on the Financial Analysts Journal, Ritholtz ponders on the definition of defining an equity bubble, of which Asness has claimed as a state wherein prices are set that in no reasonable futre could justify.

Ritholtz wrote in an attempt to answer his question on whether markets are bubbly, "Based on this definition, it is difficult to conclude that markets are in a bubble. There are many "reasonable future outcomes" that would justify current prices. It would only take a small marginal improvement in the economy, or a small uptick in hiring, or heaven help us, even a modest increase in wages -- to increase revenues and drive profits significantly higher. What is currently a somewhat overvalued U.S. market could easily become a fairly valued or even cheap market if the economy were to accelerate modestly. That is without any help from Europe or Asia. If the worst in the EU zone is behind her, then it is quite possible that prices are very reasonable there and not ridiculous here."

Citing examples ranging from the circa 2000 dot com and tech stocks boom and the rallies of specific stocks including Bitcoin, Tesla and Netflix, market bubbles are not to be dismissed, considering that as Asness had noted, the profit to earning ratios of such stocks then could not be financially justified. Moreover, another difficulty that Ritholtz had in understanding the market bubble was the subprime credit bubble and the increase in home prices worldwide beginning 2001 to 2006. The ratio between median home price as compared to the median income in the US had moved three standard deviations away from the long-term norm, which means, said Ritholtz was an effect of the bubble due to collapse or that the salaries of everyone in the US was about to increase two times.

In conclusion, Ritholtz agrees with Asness regarding the misuse of the word bubble in markets, of which Asness said, "We have dumbed the word down and now use it too much. An asset or a security is often declared to be in a bubble when it is more accurate to describe it as ‘expensive' or possessing a ‘lower than normal expected return.' The descriptions ‘lower than normal expected return' and ‘bubble' are not the same thing."

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