Daily Brief - How close are we to the dot-com peak? (Nov 8, 2021)

Are markets going off the rails? Is irrational exuberance back? "Irrational exuberance" is the phrase used by the then-Federal Reserve Board chairman, Alan Greenspan as a warning that the stock market might be overvalued.

History may not repeat itself but it is said to often rhyme.

There are definitely echoes of the late 1990s era in today’s market environment. A few from this past week: a “squid game” crypto token falls 99.99% in a few minutes, wiping out $2.4 billion in market value on barely a few $ million in actual trading. Paper money.

Tesla added hundreds of billions of dollars in value over a deal with Hertz that hasn’t even been signed (which was highlighted by Tesla’s Musk himself). Buy first, verify later methodology at work.

Perhaps a more fundamental basis for comparison with the dot-com era is the CAPE ratio.

What is the “CAPE ratio”, you might ask.

The CAPE Ratio (also known as the Shiller P/E or PE 10 Ratio) is an acronym for the Cyclically-Adjusted Price-to-Earnings Ratio. The ratio is calculated by dividing a company's stock price by the average of the company's earnings for the last ten years, adjusted for inflation.

It was first proposed by the Nobel-winning American economist Robert Shiller. The intent was to gauge whether a stock is undervalued or overvalued by comparing its current market price to its inflation-adjusted historical earnings record.

In contrast to the more popular price to (P/E) ratio that uses current or even forecast earnings, it is calculated by dividing the current price of a stock by its average inflation-adjusted earnings over the last 10 years.

This helps to smooth out the impact of business cycles and other events and gives a better picture of a company's sustainable earning power.

On this metric, the S&P 500 is now at 40 vs. 44 just before the market crashed in 2000.

There are other measures that are flashing amber, too: CNN Greed/Fear index is at a new extreme high. Put option buying - a sign of investor’s concerns about the downside - is near the lows.

Ok, so it must be time to sell?

There is one major caveat. By the time the market bubble burst in March of 2000, the Fed had been raising rates for quite some time (see the chart below). The same was true in the market crash of 2008. This time around, interest rates remain glued near zero and the Fed has only just started the discussion about “tapering”.

Investors may be tipsy but alcohol is still being served.