Are We Experiencing a Market Bubble?

Good Morning Relaxing Retirement Member,

It’s pretty difficult these days to flip through financial media talk shows or websites without hearing and seeing the phrase “stock market bubble”, i.e. the idea that market prices are wildly overvalued for a variety of reasons.

And, as all “bubbles” do, they will burst and stock prices will come crashing down without any warning.

Given the trajectory of stock market prices since March of 2009, it sounds reasonable. But, only if you buy into the belief system that stock prices are random, irrational, unstable, rigged, and certainly not governed by any objectively verifiable standard.

The challenge with this belief system is history continues to demonstrate that, in the long run, any company’s stock price is very reliably correlated to the fortunes of the company it represents.

Stocks are Businesses

We always have to remember that stocks are nothing more than direct ownership in businesses, i.e. companies.

That’s what stocks are!

During periods of extreme public pessimism (and optimism), the overwhelming majority of individuals in this country get pulled into the financial media’s crisis du jour and lose sight of this simple distinction.

When you hear “the Dow”, or “the market”, they’re not referencing some mysterious, devilish, irrational, and randomly priced “object” in the marketplace.

The Dow, for example, is simply a summation of the 30 largest industrial “businesses” in the United States.

Each one of those businesses has its own shares of stock which are nothing more than certificates of “ownership” in their company.

Every one of those companies is a living, breathing entity producing and selling products and services for their customers just like the local Dunkin’ Donuts or Hallmark store.

The Short vs. Long Run

Now, it is certainly true that a company’s stock price (and, thus the broad market in general) can be affected in the short to intermediate term by political events, extremes in investor behavior, changes in interest rates, or other incidents not directly related to the operations of the underlying companies.

In the long run, however, stock prices have very consistently reflected the earnings, dividends, and cash flows of their respective companies.

During periods of cyclical or event-driven economic contraction, i.e. recessions, stock prices often fall. Sometimes these declines reflect not only the prevailing conditions, but the public’s overreaction to them as well.

Although stock price declines often appear sudden, they’re not random. It’s simply a reflection of the declining earnings and cash flows of the underlying company.

However, just as the decline of business activities of well run companies has been temporary, so too has the decline in their corresponding stock prices.

So, if there is no stock market “bubble” at the moment, aren’t we at least due for a correction?

Stay tuned for the next edition as I will answer this very important question in great detail.

Committed To Your Relaxing Retirement,

Jack Phelps

The Retirement Coach

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