Stocks push higher, but bubble fears are unwarranted – BlackRock’s Koesterich says

Despite price peaks, stocks are not in bubble territory in the US, says Russ Koesterich, BlackRock’s Global Chief Investment Strategist.

Blame Washington: Consumer Confidence Remains Shaky
US economic data continues to come through in fits and starts, with some areas showing signs of genuine improvement and others remaining stuck in neutral. On the positive side, the housing market remains an important source of strength and is leading the recovery. Building permits jumped in October to a 1.03 million annualized pace-the highest level since June. Additionally, home prices are rising. The S&P/Case-Shiller Composite Index (a broad measure of national home prices) is up more than 13% over the last year-the best reading since 2006.

With new homes being built and housing prices rising, it would be natural to expect an uptick in consumer confidence as well, but that is not the case today. Last week, the Conference Board’s index of consumer confidence fell to 70.4, well below expectations and its lowest level since the spring.

So why the disconnect between the housing market and consumer confidence? While a weak jobs market bears some of the blame, we would also point toward political dysfunction in Washington, D.C. In the aftermath of October’s government shutdown, and with budget battles yet to come, uncertainty over issues such as the debt ceiling, government spending and tax policy is having a noticeable effect on confidence. One way to measure this is by looking at the Economic Policy Uncertainty Index (EPUI). As its name suggests, the EPUI tracks political uncertainty, with a level of 100 being around normal. The index was as low as 93 in July and hit a multi-month high of 174 in October during the height of the recent drama.

Higher political uncertainty tends to translate into lower levels of both business and consumer confidence. Historically, for every 1 point rise in the EPUI, we have seen a 0.5 point drop in confidence levels-a trend that helps explain the decline in confidence levels that has occurred since the summer. To the extent political uncertainty starts to rise early next year (when the temporary budget deals reached in October begin to expire), it could represent a headwind for consumer confidence and, by extension, for consumer spending.

Despite Price Peaks, Stocks Are Not in Bubble Territory
The recent trend of record closing prices for the Dow and S&P, and the recent milestone for the Nasdaq, has caused some investors to ask if stocks are in a bubble. In our view, the answer is “no.” While valuations are less compelling than they were a year ago, equities still offer value and remain compelling alternatives to bonds and cash.

Taking a closer look at the Nasdaq helps illustrate this point. The current trip above the 4,000 level looks quite different from what was happening in 2000. From a valuation perspective, the Nasdaq today trades at around 24x trailing earnings. That’s not cheap, but it is below the index’s 18-year median of 30x and far below the 150x level it touched the first time it crossed 4,000 in 1999. As for the technology sector (still a very heavy component of the Nasdaq, but less so today than 13 years ago), that area of the market is trading around 17x earnings-roughly in line with the broader market and much less than the 67x we saw in 1999.

So, simply put, while some areas of the market are looking frothy (we cited US small caps and social media companies last week), today is not 1999 and stocks are not in a broad market bubble.

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