Why U.S. Stock Price Rise IS a Bubble — Beware

By Shlomo  Maital

Bubble

  The Standard & Poor 500, the broad index of Americna stocks, has set new records this summer.  This, despite the flagging U.S. economy, an unpopular President, gridlock in Congress, and mountains of cash held abroad by U.S. multinationals, stubbornly refusing to invest it in their own country.

   Writing in the London Telegraph, Andrew Davis notes:  “US shares are undoubtedly expensive – on some measures such as the Cyclically Adjusted Price-Earnings ratio, which uses a 10-year average of earnings to calculate their current valuation, they have only been more expensive a few times in the past century. “

   What is going on?  Is it a bubble?

   Andrew Davis has a simple answer.  Stock buy-backs.   

“Companies are using their cash, and cheap interest rates, to buy their own stock, in large amounts.  That said, it is clear that one of the forces that has driven the long rise in US equity prices has been the willingness of companies to buy back their own shares. A lot of this buying has been funded by companies taking advantage of extremely low interest rates to issue debt and using the proceeds to buy in their own equity.”

     Personally I would not invest in companies that have nothing better to do (R&D, innovation, HR, infrastructure, facilities, IT) with their cash than curry short-term favor with myopic shareholders by artificially pumping up their own stock price.  When I tell this to CEO’s, they frown, or worse – but they agree, in their heart of hearts.  They simply feel they have no choice but to buckle under shareholder pressure.   

   They DO have a choice.  Present a capital investment program. Invest when other companies are afraid to.  Then, when the recovery finally comes, you will have a major competitive advantage —  and your stock price will rise for the right reasons. 

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