Weekly Buzz: 📈 Is the US stock market in a bubble?

22 March 2024

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Ray Dalio – founder of the world’s biggest hedge fund – is known for many things, among which is his ‘bubble indicator’. And given comparisons between the Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) and the 1990s dot-com bubble, it might be a good time to check in with that gauge.

What does the ‘bubble indicator’ say?

The indicator uses six questions to help determine whether stock prices are unsustainably high. For example, how high are prices relative to these companies’ earnings? Or, how positive is the overall market sentiment? If it’s too bullish, many investors may have already put in everything they’ve got – meaning they’re more likely to be sellers than buyers.

The chart below shows the gauge for US stocks since 1900, expressed using percentiles. Simply put, the higher the reading, the more the indicator implies a market bubble. US shares are currently sitting in the 52nd percentile, despite a strong rally over the past months. This suggests that they’re not in a bubble.

As for the Magnificent Seven, while they’ve seen their market capitalisation (our Simply Finance section below breaks this down) surge over the past decade, that’s gone hand-in-hand with fast-rising earnings. That’s a much healthier scenario compared to the dot-com bubble era when tech stocks didn’t have the earnings to back them up. For a deeper dive into US companies, check out our recent CIO Insights: Beyond tech – Where other opportunities lie in US equities.

What’s the takeaway here?

As the old adage in the investing world goes, success isn’t about timing the market, but time in the market. Put differently, trying to predict the exact moment when the market will turn is likely to be a losing strategy – even if you use valuation metrics as entry and exit signals.

The winning strategy? Dollar-cost average into a portfolio that’s well-diversified (a shoutout goes to our General Investing portfolios!). That way, you’ll be avoiding the pitfalls of timing the market, while also maximising your time in the market, letting your returns compound over the long term.

📰 In Other News: US inflation came in hotter than expected

The US Federal Reserve’s interest rate hikes have brought inflation closer to its 2% target, down from its 9% heights of last year. But as if to humble the central bank, inflation came in higher than expected in February, with consumer prices 3.2% higher year-over-year.

Even core inflation, which strips out energy and food prices to better capture underlying price pressures, was higher than predicted for the second straight month.

Now, inflation is stubborn and volatile, so this isn’t exactly unprecedented. There’s a small chance, however, that the effects of today’s high rates are tailing off, which could force the Fed to keep rates higher for longer.

With worse-than-expected data, most analysts were expecting the Fed to leave interest rates at their 23-year high. And those expectations were met: the central bank just opted to leave rates untouched. These interest rate decisions are vital to the stock market: investors’ predictions of rate cuts are major influences behind the market’s current rally.

These articles were written in collaboration with Finimize.

🎓 Simply Finance: Market capitalisation

Market capitalisation, or ‘market cap’ for short, is a measure of a firm's size and value in the stock market. It's calculated by multiplying the current price of a company's share by the total number of shares in the market.

Knowing a company’s market cap is helpful – you can use it to compare firms of various sizes. But it’s important to note that market cap is based on how much the market prices a company, not its actual value. A company’s actual value will be based on its fundamentals, like its assets and liabilities (our previous Simply Finance broke this down!).

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