Given the poor economic performance of the United States in recent years, it surprises many that the NASDAQ Composite has nearly returned to its highs during the dot-com era, which was the longest economic expansion in US history. This regained milestone also poses another question: is the US economy currently experiencing a market bubble?
The March 1991 to March 2001 economic expansion was the longest and largest of any in United States history. US GDP grew at above 4% annually in 1997 (4.5%), 1998 (4.5%), 1999 (4.8%), and 2000 (4.1%). The NASDAQ Composite reached an intraday high of 5132.52 on 10 March 2000, before diving to 1108.49 on 18 October 2002. The combination of the failure of FCC-mandated CLECs, burst of the dot-com bubble, and a flurry of accounting scandals (Tyco, WorldCom, Enron) weighed heavily on the technology-dominated index.
It should not shock many that the US’s economic performance is more dismal than during the dot-com boom. GDP growth was 2.4% in 2014, and has never reached above 3% since the Great Recession. Despite this, the massive accumulation of corporate debt in recent years (especially in the technology sector) mirrors the same trend during the financial crisis. Overvaluations and high price-to-earnings ratios concern many economists.
Peter Schiff, CEO of Euro Pacific Capital, voiced that Uber’s latest $41 billion “valuation is absurd. And there’s a lot of companies like Uber that are sporting these billion-dollar market caps.” Wild overvaluations are not the only symptom of the current bubble. There’s been a major move to more speculative investments due to low interest rates. This is evidenced by the recent rise in stock buybacks that public companies have facilitated. After accounting for inflation, many savings accounts, certificates of deposit, and Treasury securities generate negative real returns. This will later end in financial capitulation, or flight to quality, as traders will be forced to expunge riskier assets from their portfolio after the bubble bursts.
The Federal Reserve’s $3.7 trillion quantitate easing program was aimed to stimulate investment after the Great Recession by purchasing bank debt, mortgage-backed securities, and Treasury notes. QE has clearly pushed up asset prices above equilibrium levels, causing massive amounts of malinvestment in the economy. The Fed’s only option is to facilitate a discount rate increase within the next year, thus bursting the current bubble.
Economic conditions revolve less around timing of interest rate increases than Fed response to the ensuing financial crisis due to cash flow management difficulties that arise from an increase in debt service costs, among other results aforementioned. My worry is that the FOMC will use the downturn to begin QE4, creating another asset bubble. Poor policy by the Fed in recent years has made many reconsider the central bank’s role in the economy, for better or worse. Perhaps optimal monetary policy will one day set the stage for solid, real economic growth.