Dubai: With stock markets persistently rising despite all odds and currently trading at astounding highs, experts are of the view that anxiety among investors is mounting over prospects of a market ‘bubble’.
Although there multiple definitions of what a ‘bubble’ is, the essence of them all is that asset prices have gotten to an unsustainably high level, driven by ridiculously positive investor expectations – and when those expectations change, prices will revert to something normal, dropping a lot in the process.
After a record rebound from a pandemic-induced market crash last March, stock benchmarks have raced past a series of record highs in the early days of 2021.
As stocks hit record highs, top Wall Street banks are getting an increasing number of inquiries on whether the boom, which has some parallels to the dotcom era, will result in a similar bust.
Worries of an inflated market
“We are receiving numerous questions (on) whether a bubble is potentially forming in financial markets,” Mislav Matejka, head of global and European equity strategy at JPMorgan, wrote in a note.
The US benchmark S&P 500, where gains are largely tracked by indices worldwide, gained 16 per cent in 2020, while the Nasdaq soared 43 per cent.
The VIX volatility index, a reflection of hedging against sharp moves in US stock markets, stands at more than 23 points, compared with a long-run average just below 20. In comparison, the index was at 14 points at the start of last year.
Contrasting analyst views
While several analysts are of the opinion that investors are under the misplaced notion that risk in markets has vanished, there are other industry experts who hold an opposing view.
“Some elements of the current rally are consistent with bubbles according to our framework,” wrote Mark Haefele, chief investment officer at UBS Global Wealth Management. “We see pockets of speculation, but the broader equity market is not in a bubble, in our view. We retain a pro-risk stance.”
However, analysts at global advisory platform Absolute Strategy Research, in a mid-January note, evaluated a few bubble indicators, and analyzed the current rally in US growth stocks in the same context as the boom and bust in Japanese stocks in the 1980s.
Historical parallels drawn
The current stock market rally was also compared to the more abrupt rise and fall of dotcom stocks in the late 1990s and the extended rise and fall in commodities stocks in the opening decade of the 2000s. Also, Google search trends for “stock market bubble” are at their highest since 2004.
Other common features include low interest rates, stock valuations that tower over earnings, runaway retail trading, and rapid accelerations in equity gains, and on all these counts, current market conditions look startling.
The brokerage also pointed out that more than 10 per cent of stocks in the US blue-chip S&P 500 benchmark are 40 per cent or more above their averages of the past 200 days — a phenomenon seen only four times in the past 35 years.
No alarm from big banks yet
But it is vital to note that research teams at big banks are hesitant to sound the alarm, while pointing to historically low interest rates and the massive sums of cash still being printed by central banks.
“Taking into account the yield on US Treasuries, corporate credit, or cash, the aggregate stock market index trades at below-average historical valuation,” explained analysts at Goldman Sachs in a note.
However, the analysts also noted that “pockets of the market have recently appeared to demonstrate investor behavior consistent with bubble-like sentiment”.
Barring an unlikely withdrawal of support from central banks, or a massive spike in inflation that shakes the bond markets, most agree it is difficult to ascertain what could trigger a large reversal in risky assets.
“With interest rates low and likely to stay there, equities will continue to look attractive, particularly when compared to bonds,” economist Robert Shiller, a renowned expert on bubbles, had earlier noted.
