Despite the sell-off in tech stocks, the broader stock market is still treading near record levels. And while there is decent economic data rolling in, stock valuations are still frothy with many analysts saying we’re in a stock market bubble. Others of course believe the equity bubble is not as stretched as it seems.
On February 24, the Dow Jones Industrial Average climbed into record territory. The blue-chip index rose 1.3% to 31,961.86. It was the 10th closing high of the year and the first time the index has crossed 32,000. The same day, the Nasdaq, S&P 500, Russell 2000, and TSX also notched up gains but are trading slightly below their record levels.
How Does the Current Stock Market Bubble Stack Up?
While stocks may be wavering, with investors locking in profits, the Federal Reserve has promised to keep its easy-monetary policies unchanged and was mostly dismissive of concerns about inflation. This should help boost stock prices and valuations over the foreseeable future.
This is obviously good news for investors but some of the biggest names on Wall Street are saying investors should be cautious.
Charlie Munger, vice chairman of Berkshire Hathaway and business partner of Warren Buffett, warned that the U.S. stock market is overvalued. He’s vague on specifics, but not on the outcome. “I think it must end badly but I don’t know when,” Munger said.
His boss, Warren Buffett would agree. According to the Warren Buffet Indicator, which divides the stock market cap by gross domestic product (GDP), the stock market is significantly overvalued, and including dividends, is expected to return -2.9% this year.
Not all of the smart money agrees though. Ray Dalio, founder of Bridgewater Associates, the world’s largest hedge-fund firm, says the 2021 stock market is not as overvalued as everything thinks.
Dalio created a “bubble indicator” to help him monitor stocks and give him perspective on each market. According to his bubble gauge, today’s overall stock market is around the 77th percentile. In the 1929 and 2000 stock market bubbles, the aggregate gauge had a 100th percentile reading.
Dalio wrote that there is a big divergence in the readings of stocks. Some stocks are, according to his indicator, in bubble territory (especially emerging tech stocks), while other stocks are not. Even then there are subsections to consider. Big tech stocks have taken a hit but more cyclically focused tech stocks, like semiconductors, have done well.
Dalio said he thinks that around five precent of the top 1,000 companies in the U.S. are in bubble territory. But that number is half of what we saw at the peak of the 2000 tech bubble.
The smartest investors in the world aren’t in total agreement about whether or not the stock market is in a big bubble or not. But they probably would agree that when it burst, it’s going to be ugly.
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