When will the US stockmarket bubble burst?

The US stockmarket has looked expensive for a long time. But now, the warning signs suggest we’re near a tipping point. John Stepek explains why.


The US stockmarket is "well on the way to irrational exuberance"

The US stockmarket has looked expensive for a long time.

If you look at one of our favourite measures of stockmarket valuation the cyclically-adjusted price/earnings ratio (CAPE) then US markets are trading at well above their long-run average valuation.

But when will it actually crash?

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You can't put a date on these things. But various warnings signs suggest we're not far from a tipping point

The M&A boom

So it's not a great precedent. And it's already sending jitters through the corporate bond market. "The average yield of debt issued by investment-grade companies has jumped from 2.8% in mid-April to about 3.3%" now, reports Robin Wigglesworth in the FT. (When yields rise, bond prices fall.)

Put simply, the reason that bondholders might worry about rising M&A is that it means companies take on more debt. The more indebted companies become, the more risky they are.

Also, like anything else, supply and demand has an impact on the bond market too. Investors' appetite for corporate bonds might be huge, but it isn't infinite if you increase the supply of such bonds, then all else being equal, the price should fall (and yields rise).

As one strategist tells Wigglesworth, "companies are releveraging Something has definitely turned, this is probably the late stage of the corporate credit cycle."

That's not to say that we're on the verge of a crash yet. Demand for bonds remains high. And so far, the types of deals being done haven't reached the standards of carelessness we'd usually see at the top of a bubble, according to Invesco.

But the point is that we're well on the way to irrational exuberance. And the M&A record is noteworthy for another reason.

When will the US stockmarket bubble pop?

(In case you're interested, that's when judged by historical price data going back to 1900 the S&P 500 will be two standard deviations from its historical mean average. Grantham and the team have done a pretty exhaustive analysis of bubbles in various asset classes, and they've found that once a price gets that out of whack with history, you can call it a bubble and eventually it'll pop.)

He also noted that "I still believe that before this cycle ends, the quantity of US deals should rise to a record given the unprecedented low rates and the current extreme reluctance to make new investments in plant and equipment."

Well, we're there now. The S&P 500 is currently around 2,100, and we've now hit a record in terms of M&A. So how much longer can this go on for?

Grantham reckons there are a few things to bear in mind. Firstly, the Federal Reserve is still propping up the market. And if history has taught us anything, it's to be very wary of fighting the Fed'. Secondly, there's a presidential election coming up. Again, history shows that the run-up to a presidential election tends to be good for the stockmarket. It doesn't take a genius to work out why the incumbent wants happy voters, and that means rising stock prices.

Grantham's not saying the market can't go down before then. "We could easily, of course, have a normal modest bear market, down 10-20%, given all of the global troubles we have." But if that happens, "the odds of this super-cycle bull market lasting until the election would go from pretty good to even better".

In short, if you want to try to guesstimate' when a crash might come, then mid-to-late 2016 is looking like the date to put in your diary.

What to do until then? We'd stick with trying to find markets that offer value investing is much less stressful if you don't feel you have to keep one eye on the emergency exit.

Again, that means we'd have our exposure to bonds and the US stockmarket at a minimum, and we'd pay more attention to markets offering better value such as Japan, Europe and even some emerging markets. And as I said yesterday, have a bit of your portfolio in gold, for diversification and insurance purposes.

It's also worth focusing on individual opportunities in markets. My colleague Dr Mike Tubbs has been looking at one such stock. You can find out more about it here.

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.