Equity markets around the world have rebounded strongly from the lows of March 2020, and continue to strengthen. But the surge has prompted top investment experts to rush to determine if there was bubble formation in U.S. stock markets. Billionaire hedge fund manager Ray Dalio and global investment bank Jefferies, separately, believe there are signs of concern. However, the two do not rally behind the idea of a stock market bubble.
The recent uptrend in stock markets comes amid a pandemic as countries impose lockdowns, signal negative GDP growth, unemployment numbers skyrocket – leading some to believe the stock markets are in dangerous territory. But is the current situation akin to that of a stock market bubble?
Ray Dalio’s bubble indicator
Ray Dalio, the founder of Bridgewater Associates – the world’s largest hedge fund – took to LinkedIn to reveal his findings on “bubble indicators.” Ray Dalio used six indicators, including the relativity of prices to traditional measures; entry of new buyers; leveraged purchases, and the like, to assess whether the current situation has reached bubble territory. “In short, the overall bubble gauge today sits around the 77th percentile for the entire US stock market. In the 2000 bubble and the 1929 bubble, this aggregate gauge was at a 100th percentile, ”said Dalio.
Comparing the entry of new buyers into the stock markets with the previous bubbles of the 1920s and the dot-com bubble, the situation for emerging tech companies appears to be in a bubble. However, the overall market is just “sparkling” on this gauge. Looking at whether prices are discounting unsustainable conditions, the market is not showing a bubble, but emerging tech stocks look foamy.
There is a very large divergence in the readings between the stocks. Some stocks are, by these measures, in extreme bubbles (especially emerging technology companies), while some stocks are not in bubbles, ”said the billionaire fund manager. In addition, according to Dalio’s study, 5% of the top 1,000 American companies are in a bubble, or half of the tech bubble. He added that the market action is reminiscent of “ Nifty Fifty ” in the early 1970s and dot-com stocks in the late 1990s.
Sparkling, but no crash expected
Separately, Jefferies’ Microstrategy report earlier this month indicated that the presence of retail investors, rising levels of margin funding and liquidity suggested a growing bubble risk. Jefferies added that this risk relates more to sectors heralded as the next growth engine, but whose profit visibility is unclear, including electric vehicles, climate and biotech.
“US stocks are in their 96-100th percentile in terms of valuations based on 150 years of historical data, and history suggests returns are modest to negative from current valuation levels,” the report said. However, despite this, Jefferies does not call the current market boom a bubble. The report adds that two main triggers that could lead to a serious course of action are missing. These include a collapse in profits and possible monetary tightening. “Other major risks include a relapse of COVID, immediate US tax hikes, crippling technology regulations and financial instability linked to retail. The probability of all of these events is low in our opinion. Therefore, we consider the current markets to be sparkling and in need of a correction, but not a crash. “