Is there a bubble about to burst?

There’s a lot of bubble talk at the moment. The US stock market is at an all-time high and climbing higher, stocks such as Tesla have been going crazy, there’s been a frenzy of small investors buying stocks based on social media hype on sites such as Reddit, and Bitcoin is close to $40,000 again – up four-fold in a year.

Can this continue, or should investors worry about a crash? According to Legal & General, investors are already worrying: never have more people searched for the term ‘stock market bubble’ on Google. The company’s ‘bubble index’ also shows that the probability of a market bubble has been rising. In fact, it is now the highest it has been since 2008.

Not only that, but one scholar of market bubbles, Jeremy Grantham, who has a good track record in predicting the moments when bubbles will burst, opened his new outlook with the sentence: “The long, long bull market since 2009 has finally matured into a fully-fledged epic bubble.”

A self-fulfilling prophesy?

For all the negatives, as always there are investors who are more positive.

Chris Iggo, CIO of core investments at AXA Investment Managers, is one such person, although he warns that that the more the media focusses on it, the more the idea that the whole market is in a bubble takes hold. “There is no end to commentators on US financial television warning that retail investors are going to lose all their money,” he said. “The psychological impact could drive investors to take profits on their equity portfolios or hold back cash in case there is a market correction. Fear of “something going wrong” or a policy response to the speculative activity may be somewhat self-fulfilling in terms of some adverse market reactions.

“But I’m not sure any of the reasons given are enough to hail an imminent bear market. Monetary policy support (illustrated by real interest rates remaining very low) and expectations of economic recovery remain the key drivers of equity market performance and the lack of volatility in the fixed income markets.”

TB Wise Multi-Asset Growth fund manager Vincent Ropers agrees that markets could still climb higher. “A global economic recovery is not fully priced in yet,” he said, pointing to a plethora of cyclical companies which have not recovered last year’s losses. Vincent feels broad equity indices can be misleading indicators and are increasingly a reflection of the success of a minority of stocks and can easily hide the disparity between growth and value stocks.

And what does the team at Chelsea think?

Darius McDermott, investment Adviser to the VT Chelsea Managed Fund range, commented: “A year on from the fastest global sell-off in history and markets have gone full circle from a valuation perspective. Almost every region across the globe is looking expensive, regardless of which measure you look at. The US for example, which accounts for 60% of the MSCI All Country World Index, is more expensive than in any point in history, apart from the Dotcom boom.

“But the question is: how relevant is history to today’s market? We have a record low risk-free rate, driven by incredibly loose monetary policy and all financial assets are priced off the risk-free rate – so it’s perhaps no wonder everything looks dear.

"I don't believe we are in a bubble yet - or if we are it is the early stages. A good rule of thumb to follow is that if lots of people are talking about a bubble (as they are at the moment) it probably isn’t a bubble.

Usually it is only when everyone one is positive and there are no more buyers left that a bubble hits its peak.

"That said, markets are undoubtedly expensive and there are certainly pockets of extreme valuation - Tesla is a good example.

“But a lot of stocks are still reasonably priced and retail investors might only just be getting going. Savings rates have rocketed during the pandemic and people are looking for more than 0% on their savings.

NS&I is unable to cope with the withdrawals and some of this money is undoubtedly heading to the stock market. I think this trend of the return of the retail investor has some way to go.

"The big concern is inflation as this might force yields and interests rates up causing a crash in bond and stock markets. But there isn’t going to be much inflation (barring a few specific areas) whilst we all stay locked down. But it is something to keep an eye on over the medium to long term.

“In the meantime, investors just really need to be diversified and maybe let a professional worry about possible bubbles and how to manage asset allocation for you.”

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.

Published on 08/02/2021