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Are stocks causing bubble risk?

By Mark Hamrick ·
Friday, December 20, 2013
Posted: 4 pm ET

The end of the year is prompting talk of bubbles -- and not the kind that you find in clinking glasses on New Year's Eve.

It's not every year that we see the key stock market averages advance about 30 percent. But that's the gain for the Dow Jones industrial average and the Standard & Poor's 500 index as we head for the final sessions of the year. After the beating stock investors took during the financial crisis, the positive showing for stocks has been a welcome reversal, literally, of fortunes. Could the market's rapid ascent this year end up hurting the economy, causing headaches for the Federal Reserve and the rest of us down the road?

We know also from past experiences that bubbles are hard to spot. Some economists are concerned about the stock market's recent run.

"I absolutely do think we have a stock price bubble," says Nayantara Hensel, former chief economist for the U.S. Navy. She says a pullback is due and that investors should not expect the recent trend to continue, at least over time. "It's not going to be increasing at the rate that it's been increasing ... (the market) should taper off and flatten out and perhaps deflate," says Hensel.

However, not all economists feel this way. Others, including Janet Yellen, don't see a stock market bubble on the horizon.

Last month, Yellen was asked about bubbles during her Senate confirmation to be the next Federal Reserve chairman. "I would say that I don't see evidence at this point in major sectors of asset price misalignments, at least of a level that would threaten financial stability," she said.

Sam Stovall, Chief Equity Strategist at S&P Capital IQ, also sees stocks fairly valued as well. Asked whether the benchmark S&P 500 index is inflating its own bubble, Stovall says not according to what he calls the "Rule of 20." The "Rule of 20," in its most simplified explanation, figures the S&P 500 is fairly valued if its price-to-earnings ratio, based on "trailing 12-month as-reported earnings-per-share plus the rate of inflation, equals 20."

So, while plenty of smart people are paying attention to the market's record run, they're divided on the issue. We'll only know for certain who was right in hindsight.

Are you worried about a stock market bubble? Do you think the market has room to run higher?

Follow me on Twitter: @hamrickisms.


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