STOCK MARKET BUBBLE?

Are we in a bubble?

Are we in a bubble? Is it about to burst? In the last few days, there have been many tweets on this subject, and the tweets of @michaeljburry, a 49-year-old Californian, who become famous for having “predicted” the economic crisis of 2008, were among the most popular.

He wasn’t the only one to bring attention to this topic. The report “Stock Market Bubble?” by Bridgewater, the largest hedge fund in the world, written by its founder Ray Dalio, also made waves. The article tries to answer, data in hand, whether or not we are inside a bubble. So, let’s look at what they are saying.

Micheal Burry’s opinion

According to Michael Burry, there are several reasons why we are approaching a bubble burst. The US government is inviting inflation with its latest policies, debt/GDP is growing, there is a large amount of money circulating in the economy. When consumption will suddenly restart, there will be an increase in labor costs and prices (#ParadigmShift). Therefore the question remains: it is true that there is a large amount of money and that consumption has not yet completely broken down, but what will happen when it starts again? Michael Burry also states that speculative bubbles are accompanied by a disproportionate amount of debt within the markets, and it is equally true that the debt on the markets is at an all-time high (higher than the debt present in 2008).

Ray Dalio’s analysis 

On the other hand, Ray Dalio analyzes the “bubble” issue through a proprietary indicator that is made up of six sub-indicators. A value from 1 to 4 is attributed to these sub-indicators, which tell us “how much they are on the bubble” (1 absolutely not, 4 absolutely yes). The report shows not only the situation of the market in general but also the case of the emerging tech market, that is, of all those new companies dealing with technology.

1) Prices are high relative to traditional measures. At the moment, the prices are relatively high, but we are still below the prices of the 2000s or the 1920s. Overall market rating: 2/4. Emerging tech market rating 3/4.

2) Prices are discounting at unsustainable conditions, i.e., conditions that cannot last for an extended period of time; here, from the point of view of the market in general, there is absolutely no bubble, vote 1/4. A completely different matter for the emerging tech market, vote 3/4.

3) New buyers have entered the market, typically a symptom of great euphoria; the number of new shareholders within the market is very high, both for the market in general and for the emerging tech market: 3/4 for the market in general and 4/4 for the emerging tech market. From this point of view, one could also analyze the ease with which it is now possible to buy a share. Think of all the trading platforms born in recent years.

4) There is broad bullish sentiment. If it is excessively bullish, it could usually signal a bubble (for example, SPAC and IPO are generally done while there is a very positive sentiment, in order to raise more capital); and from this point of view the results are very high as the sentiment is really positive: 3/4 for the market in general, 4/4 for the emerging tech market. Perhaps it is also true that many of us today think that the tech market will be the future. If we look at the level of IPOs and SPACs currently taking place, we are indeed at an all-time high.

5) Purchases are being financed by high leverage, or financial leverage, which indicates how much investors borrow to invest. Concerning the market in general, there do not seem to be  significant problems, rating 2/4. For the emerging tech, quite another matter, 4/4.

6) Buyers/businesses have made extended forward purchases, i.e., investments or large purchases by companies which is usually considered a healthy thing. Still, if abused, it can be a symptom of excessive optimism. For the market in general, absolutely not, 1/4. The emerging tech is also similar: 2/4. Indeed the Covid-19 pandemic has discouraged companies from making future investments.

Conclusions

To conclude it seems like Michael Burry is suggesting us to stay away from bonds, which are now much cheaper than stocks. Just in recent weeks, the bond market has begun to deliver satisfactory returns, and investors have started to move from equities to bonds (often bringing with them the equity gains of the last recovery period). However, bonds are nominal, and when there is an inflationary outlook, that rate of return in real terms, in the face of an inflationary wave, “is no longer enough.” From this point of view, an investment in large companies could be safer, given the fact that they could, in the event of inflation, incorporate the price increase within the share price.

Instead, what Ray Dalio seems to suggests to us is to stay away from “bubble stocks” or from all those emerging tech companies that are delivering 350% returns in one year, which is very reminiscent of the dot-com bubble of the 2000s. At the same time, it suggests that if a bubble is really about to burst, it could start from or affect the emerging tech market.