US stocks are obviously in a bubble. But is it a rational bubble?

Everyone wants to know if the US stockmarket is in a bubble. But that is the wrong question, says Merryn Somerset Webb. Of course it’s a bubble. The real question is: is it a rational one?

Is the US stockmarket a bubble? That’s the question everyone wants answered right now. It is the wrong question. Of course it’s a bubble. Choose any valuation metric you like in the US and it will tell you so. Yardeni Research puts the ratio of S&P 500 total market capitalisation to S&P 500 forward sales (an adapted version of the “Warren Buffett indicator”) at a record 2.54 times at the end of December, versus 1.88 at the beginning of 2000. A bubble. A full 53% of S&P stocks had forward price/earnings ratios of over 20 times in the first week of January – it was a little higher in June last year, but that aside is the highest since the series began in 2006. Bubble. 

The percentage of stocks in the US trading above the 200-day moving average is at a ten-year high. Within almost all sectors, more than 90% of stocks are trading above their 200-day moving averages (notable exceptions, says Variant Perception, include biotech, junior gold miners, utilities and energy). Bubble. All technical indicators show what Variant describes as “extreme overbought market conditions” and 89% of respondents to a Goldman Sachs survey said they expect stocks to rise this year. Bubble. 

But on top of all this number stuff, we are also getting a fabulous crop of delicious new market mania stories. There is a SPAC planning to launch with the ticker LMAO (if you don’t use social media, ask your kids). There is the poor man who technically owns $250m worth of bitcoin (worth $20,000-ish when he got them in 2011) but has only two password attempts left to get access to the hard drive they are on (see this week's magazine for more on bitcoin and listen to this week’s podcast for the full story). And of course there is the brilliantly extraordinary Elon Musk, a man who has accumulated wealth faster than anyone else ever in the history of the world. Bubble? Oh yes.

The more interesting question then is not: “Is this a bubble?” but: “Is it a rational bubble?” (If there is such a thing.) You can make a pretty good argument for the latter. It’s hard to see where else other than equities (and gold...) money goes when bond yields are still near record lows and global money creation keeps taking out record highs. In 2008, the UK put in place economic stimulus to the tune of 1.5% of GDP to ease us through the financial crisis. This time it’s 26%, according to Minerva Research. The numbers for the US are 4.9% and 18%. M2 (one measure of the supply of money) in the US is up 26% year on year. None of us have ever seen numbers like this before. 

You can also argue that while the economy doesn’t look tip top right now, there is fabulous momentum behind recovery: earnings should explode next year, albeit from a very low base. So what do you do? Take a little money out of the most overvalued parts of the market? Sure. Note that some US tech stocks (to say nothing of bitcoin) are topping out and see this week's magazine for our worries about super-expensive Indian stocks. Shift your portfolio towards the bits of the market that are not overvalued – energy, smaller companies, financial and healthcare? Definitely. The US market might be experiencing a perfectly rational bubble – but that doesn’t make complacency safe. 

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