Stock Market Bubble: Cause for Concern?

Summary

The video discusses the current state of the US stock market, suggesting it may be in a bubble due to high valuations, particularly among tech stocks. It references expert opinions and historical data to explore potential outcomes and offers strategies for investors who are concerned about the market's trajectory. The role of geopolitical events, military spending, and the impact of potential conflicts on global markets is also considered, along with the possibility of an accounting crisis triggering a market selloff.

Takeaways

• 📈 The US stock market is currently considered expensive with a forward price to earnings multiple at high levels, indicating potential lower returns in the future.
• 🚀 The major beneficiaries of the AI narrative are mega cap tech stocks, which have significantly contributed to the overall market valuation.
• 🔄 If the mega cap tech stocks are excluded from the S&P 500 valuation, the multiple drops from 21 times to roughly 18.7 times.
• 💡 The valuation of the market is dominated by a small number of stocks, and not all sectors are expensive. Technology, Industrials, and Healthcare are more expensive, while Energy, Financials, and Utilities are more reasonably priced.
• 📊 Visualization tools like the one from Finis can help investors understand the market cap proportion and valuation of individual companies, highlighting the most expensive stocks.
• 📉 Some of the 'Magnificent 7' have seen a decline in their stock prices, indicating that the initial euphoria may be fading and the narrative is becoming more concentrated in fewer stocks.
• 🌐 Global investors are concerned about the US market's valuation because of its significant impact on global indices.
• 🎯 Free trade offers a platform for UK investors to access a wide range of stocks and ETFs, including the option for tax-efficient investing through a stocks and shares Isa or a self-invested personal pension (SIP).
• 🔄 For those concerned about US market valuations, adjusting regional allocations by investing in regional ETFs can be a strategy to reduce exposure to the US market.
• 💥 Potential triggers for a market bubble 'pop' could be geopolitical events, such as conflicts or crises, which can significantly impact investor sentiment and market performance.

Q & A

What is the current state of the US stock market according to Jeremy Grantham and other commentators?

The US stock market is currently considered to be in a bubble, with high valuations that may lead to lower returns in the future.

How does the forward price-to-earnings multiple for the S&P 500 stocks indicate the market's valuation?

The forward price-to-earnings multiple is at a high level of $21 per dollar of future profit, which is above the 5-year average and significantly higher than the 10-year average, suggesting an overvalued market.

What narrative has emerged to support the US market after the tech wreck in 2022?

The major narrative supporting the US market is the story of AI, benefiting mega cap tech stocks and leading to an increased valuation for these companies.

How does the valuation of the 'Magnificent 7' or 'Mega Cap 8' impact the overall valuation of the S&P 500?

Excluding the 'Mega Cap 8' from the overall valuation of the S&P 500 reduces the multiple from 21 times to roughly 18.7 times, indicating that these few dominant stocks are driving the market's high valuation.

What sectors within the US market are considered expensive based on the forward price-to-earnings multiple?

Technology, Industrials, and Healthcare sectors are considered expensive based on the forward price-to-earnings multiple, while sectors like Energy, Financials, and Utilities are more reasonably priced.

What are some potential triggers that could cause the US stock market bubble to pop?

Potential triggers include geopolitical events such as conflicts, economic crises, or accounting scandals that lead to a re-evaluation of the market's fundamentals.

What is the significance of the Schiller CAPE multiple and how does it relate to current market conditions?

The Schiller CAPE multiple is a valuation measure that is currently very high, indicating that the market has been cheaper 98% of the time since the 19th century, suggesting that a market correction may be due.

What is the EXS Cape yield and how does it adjust the valuation assessment?

The EXS Cape yield is a measure developed by Jeremy Grantham that adjusts for interest rates, providing a different perspective on market valuations and indicating that the US market is expensive when viewed through this metric.

What is the historical relationship between high valuations and future returns?

High valuations have historically been associated with lower real returns in the future, especially at extreme valuations, with the potential for a negative total real return over the next 10 years when valuations are high.

What is the recommended strategy for investors concerned about US market valuations?

Investors concerned about high valuations may consider reducing their exposure to the US market by adjusting their regional allocations or considering other investment options, while still acknowledging the long-term success of the US market.

How does the video suggest handling investments during a potentially overvalued market?

The video suggests that investors might consider drip feeding their investments if they are concerned about market valuations, as this approach allows for a gradual investment over time and can mitigate the impact of a potential market correction.

Outlines

00:00

📈 US Stock Market: Bubble Concerns and Investor Implications

This paragraph discusses the current state of the US stock market and the debate around whether it is in a bubble. It highlights the high forward price-to-earnings multiple of the S&P 500 stocks, which indicates that investors are paying a significant amount for each dollar of future profit. The paragraph also explores the impact of the AI narrative on the valuation of mega-cap tech stocks and how their exclusion significantly lowers the overall valuation of the S&P 500. The focus is on the importance of understanding market valuations and the potential risks for investors, emphasizing that not all sectors are expensive, and value can still be found in the US market.

05:00

💡 Free Trade: Revolutionizing UK Investing and Tax Efficiency

This paragraph introduces Free Trade, a UK-based platform that offers commission-free investing and has a wide range of stocks, ETFs, and investment trusts available to its users. It discusses the benefits of using Free Trade for managing investments, including tax efficiency through a stocks and shares ISA and a self-invested personal pension (SIP). The paragraph also mentions the platform's unique feature of providing access to UK treasury bills, which are considered low-risk investments backed by the UK government. Additionally, it promotes an exclusive offer for the YouTube audience, which includes a free share worth between £10 and £100 upon joining the platform and funding an account with at least £50.

10:01

🔍 Valuation Matters: Insights from Jeremy Grantham and Historical Data

This paragraph delves into the importance of market valuations, referencing Jeremy Grantham's insights and historical data to understand the potential outcomes of high valuations. It discusses the Schiller P/E multiple and its current high level, indicating that there has never been a sustained US stock market rally at such multiples. The paragraph also introduces the EXs Cape yield, which adjusts for interest rates and further confirms the high valuation of the US market. By examining the total real return of the S&P 500 following different valuations in the past, the paragraph suggests that high valuations tend to result in lower real returns. It also addresses the question of whether one should reduce their exposure to the US market and provides practical advice on how to do so by adjusting regional allocations within a global equity portfolio.

💥 Potential Bubble Pop: Geopolitical Risks and Market Shakeouts

The final paragraph explores the possibility of a bubble in the US stock market and potential triggers that could lead to a market correction. It considers geopolitical risks, such as conflicts involving Russia, Ukraine, and China, and their potential impact on global markets. The paragraph also discusses the likelihood of an accounting crisis or a re-evaluation of the tech sector's profitability as factors that could precipitate a market downturn. It acknowledges the difficulty in identifying bubbles during times of euphoria and the importance of not completely excluding the US market from one's portfolio, despite its high valuation. The paragraph concludes with a personal strategy for dealing with market conditions, suggesting drip feeding as a prudent approach for those who are concerned about the current market valuations.

Keywords

💡Stock Market Bubble

A stock market bubble refers to a situation where stock prices are trading at levels significantly higher than their intrinsic value, often driven by investor exuberance and speculative behavior. In the video, it is suggested that the US stock market might be in a bubble, with high valuations potentially leading to lower future returns. The discussion around the bubble is tied to concerns about overvalued tech stocks and the potential risks they pose to investors.

💡Valuation

Valuation refers to the process of determining the economic value of an asset or company, often by analyzing financial data such as price-to-earnings ratios. In the context of the video, valuation is crucial for understanding the current state of the stock market and identifying whether it is overvalued or undervalued. The video discusses how certain sectors within the US market, like technology and healthcare, are more expensive compared to others, indicating a potentially uneven distribution of value.

💡Mega Cap Tech Stocks

Mega cap tech stocks refer to the shares of technology companies with very large market capitalizations, typically in the hundreds of billions of dollars. These stocks often have a significant influence on the overall performance of stock market indices. The video highlights that the valuations of these mega cap tech stocks, such as Microsoft, Amazon, and Tesla, are considerably higher than the S&P 500 average, contributing to the perception of a market bubble.

💡Forward Price-to-Earnings (P/E) Multiple

The forward price-to-earnings (P/E) multiple is a valuation ratio calculated by dividing the market price per share of a stock by the company's forecasted earnings per share for the next 12 months. A higher multiple indicates that investors are willing to pay more for each dollar of a company's earnings, which can be a sign of overvaluation. In the video, it is mentioned that the current forward P/E multiple for the S&P 500 is at high levels, raising concerns about the sustainability of the stock market's valuations.

💡Schiller P/E Multiple

The Schiller P/E multiple, also known as the cyclically adjusted price-to-earnings ratio, is a valuation measure that averages the past 10 years of earnings (adjusted for inflation) to the current price level. It is used to assess the long-term value of the stock market and identify potential overvaluation or undervaluation. The video notes that the current Schiller P/E multiple is at a high level, suggesting that the US stock market may be overvalued compared to historical averages.

💡Market Allocation

Market allocation refers to the process of dividing an investment portfolio among different asset classes, sectors, or regions to optimize risk and return based on an investor's strategy and goals. In the video, the concept of market allocation is discussed in the context of potentially reducing exposure to the US market due to concerns over high valuations, and reallocating funds to other regions or sectors that may offer better value.

💡Geopolitical Risks

Geopolitical risks are events or situations involving political developments, international relations, or conflicts that can affect the global economy and financial markets. The video suggests that geopolitical events, such as potential conflicts involving Russia, China, or other nations, could be a trigger for a significant market correction or 'popping' of a perceived stock market bubble.

💡Accounting Crisis

An accounting crisis refers to a situation where there is widespread concern about the accuracy or integrity of financial statements, often due to fraudulent practices or accounting errors. In the video, it is mentioned as a potential cause for a stock market selloff, drawing parallels to past events like the Enron and Worldcom scandals, which led to a re-evaluation of tech stocks and a market downturn.

💡Drip Feeding

Drip feeding, in the context of investing, refers to the strategy of regularly investing small amounts of money into an investment portfolio, regardless of market conditions. This approach can help mitigate the impact of market volatility and reduce the risk of investing a large sum at a market peak. The video suggests that drip feeding might be a prudent strategy for those who are concerned about the high valuations in the stock market and are unsure about the timing of their investments.

💡Investment Platform

An investment platform is a service or system that enables individuals to invest in various financial instruments, such as stocks, bonds, and ETFs. The video mentions Free Trade, a UK-based commission-free investment platform, as an example of a service that provides access to a wide range of investment options and aims to make investing more accessible and cost-effective for individuals.

💡ETFs (Exchange-Traded Funds)

Exchange-traded funds (ETFs) are investment funds that are traded on stock exchanges, similar to individual stocks. They typically hold a collection of assets, such as stocks or bonds, and are designed to track the performance of a specific index. In the video, the speaker discusses using ETFs as a way to diversify an investment portfolio geographically and sectorally, which can help manage risk and potentially reduce exposure to overvalued markets.

Highlights

Jeremy Grantham and other market commentators suggest the US Stock Market is currently in a bubble.

The forward price to earnings multiple for the S&P 500 is at high levels, with people willing to pay $21 for every dollar of future profit.

The current price to earnings multiple is not as high as it was in 2020, but it's above the 5-year and 10-year averages.

AI has become a new narrative to save the US market, benefiting mega cap tech stocks.

Excluding the 'Magnificent 7' from the S&P 500 valuation reduces the multiple from 21 times to roughly 18.7 times.

Technology, Industrials, and Healthcare sectors are quite expensive based on the forward price to earnings multiple, while sectors like Energy, Financials, and Utilities are more reasonably priced.

The visualization from Finis shows the market cap of companies in proportion, highlighting the dominance of the 'Magnificent 7'.

Tesla, Microsoft, Nvidia, and Amazon have high valuations, with Tesla being the most expensive at almost 44 times forward earnings.

There are concerns that the current high stock prices are an exuberant bubble, and that the euphoria is starting to fade with some major stocks experiencing significant falls.

Free Trade is a UK commission-free platform offering access to over 6,100 US, UK, and European stocks, ETFs, and investment trusts.

Jeremy Grantham's analysis indicates that high valuations typically lead to lower future returns.

The Schiller CAPE multiple is very high at the moment, suggesting that the US market is expensive.

The EXS Cape yield, which adjusts for interest rates, also indicates that the US market is expensive.

Historically, high valuations have led to negative total real returns for the S&P 500 over the next 10 years.

One approach to address concerns about US market valuations is to adjust regional allocations within a global equity portfolio.

It is advised not to remove the US market entirely from a portfolio due to its historical dominance and success.

Geopolitical events, such as potential conflicts or escalations, could be a trigger for a market bubble to pop.

An accounting crisis, similar to past events involving companies like Enron and Worldcom, could lead to a stock market selloff.

Investors may consider drip feeding investments into the market, especially if they are concerned about being at the top of a euphoria phase.

Transcripts

according to Jeremy Grantham and other

stock market commentators the US Stock

Market is currently in a bubble but is

this true and should investors be

worried in this video I look at the

current state valuations consider why

this is important but I also consider

whether we should reduce our us

allocation as a result and how to go

about that in practice I also look at

the end of the video about what might

make the bubble pop this video is

sponsored by free trade the commission

free invest M platform which is

revolutionizing the world of investing

in the UK Market let's begin by looking

at why the US is so expensive right now

and yes the US is expensive if you look

at the forward price to earnings

multiple that's the number of dollars

people are willing to pay for every

dollar future profit forecast for the

S&P 500 stocks that's currently at

pretty high levels people are willing to

pay $21 for every dollar of future

profit it's not as high as it was in

2020 when people people were willing to

pay

$23 for every dollar of profit but a

more normal multiple might be something

like 15 16 or 17 times forward earnings

and this measure is mean reverting if

you look at the 5year average that's the

dash green line here you can see that

we're well above it that would be a

multiple of 19 times and the 10e average

is even lower that would be a multiple

of below 18 times so when this multiple

is high usually it means lower returns

in the future now after the tech wck in

2022 a new narrative came to the four to

save the US market and that was

essentially the story of AI the major

beneficiaries of this narrative were

many of the mega cap tech stocks so the

Magnificent 7 or as it described in this

graph from yardeni the mega cap 8 now if

you strip out the mega cap 8 from the

overall valuation of the S&P 500 that

takes us from a 21 times multiple all

the way down to roughly 18.7 times and

if we just look at the mega cap 8 you

can see their valuations are way above

the average for the S&P 500 there the

multiple is just under 30 times so

really it's this narrative which has

pushed up us valuations and this is very

much dominated by just a handful of

stocks and it's by no means true that

all of the US market is expensive it's

just that dominant small handful of

stocks which is expensive so if we break

it down by sector you can see that yes

technology Industrials Healthcare are

all quite expensive on this forward

price to earnings multiple basis but the

unloved sectors like energy financials

utilities are all much more reasonably

priced so if you're looking for Value in

the United States you can certainly

still find it but if you buy the us as a

whole say an S&P 500 tracker or even a

global index tracker then you're going

to be buying stocks at a a pretty high

multiple I think this visualization from

finis is also really useful because it

shows you squares in proportion to the

market cap of a company so you can see

the Magnificent 7 here very clearly and

the red shading shows you the stocks

which are most expensive so Microsoft is

at a 32 times multiple Nvidia at 30

times Amazon at 33 times and even after

the big sell-off in its share price

Tesla is the most expensive one

according to this measure at almost 44

times forward earnings so you can see

why people are worried they're worried

that this is an exuberant bubble and

that these stock prices have been pushed

up beyond all Realms of sensibility

certainly above their fundamental profit

growth and we're already starting to see

some of that Euphoria fading some of the

Magnificent 7 are no longer so

magnificent so if we look at

year-to-date returns you can see that

Tesla's Fallen by around 30% Apple by

about 8% has sales in China disappointed

and Google and Microsoft have only made

double digit returns so maybe now we

need new acronyms like the fabulous 4

the terrific Trio or the dynamic duo you

can see how Nvidia and meta are very

much dominating the return table so far

this year so the narrative is fading a

bit but it's now becoming more

concentrated in just a few last hopeful

stocks the big worry of course is that

everything is going to go into reverse

and that there'll be some kind kind of

Reckoning and because the US market is

so dominant globally then index

investors are understandably scared

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description of the video so why does

valuation matter in the first place well

Jeremy Grantham is always a good source

of information when it comes to why we

should be worried about the stock market

some people describe him as a Perma bear

but I don't think that does him Justice

if you look at his essays on the GMO

website they're actually really well

informed and interesting and also quite

nuanced he makes some really good points

in the latest publication from March

2024 one point which he made which I

find really interesting is that with the

Schiller multiple at 34 times and that's

where we are roughly at the moment

there's never been a sustained US Stock

Market rally his other point is a

macroeconomic one which is when we're at

full employment and the US by almost any

measure is well beyond full employment

right now there's also never been a

sustained stock market rally now for

premium members of our website

membership we have this valuation

monitor which looks at this Shiller

capee multiple and as Grandam says the

current level of Schiller's Cape is very

high in fact it's been cheaper 98% of

the time going all the way back to the

19th century another measure he's come

up with is the EXs Cape yield which

adjusts for interest rates and there

again you can see that the US is

expensive cheap and expensive here are

flipped the other way up and by this

measure me as well the US looks

expensive in fact it's been cheaper

about 3/4 of the time so if you do want

access to that tracker and other

benefits of membership just go to our

website pensioncraft tocom so what we

can do is look at the total real Return

of the S&P 500 following a certain

valuation in the past and that's what

you can see on this graph to the right

of the graph you can see high valuations

to the left you can see low valuations

and as you'd expect when valuations are

high High you see lower real returns and

this tends to be most informative at

extreme valuations which we're at

currently in fact if we slice the

distribution based on today's Cape

multiple we'd expect a negative total

real return for the S&P over the next 10

years there are big error bars around

that of course but still it's not

looking great for the US market given

valuations where they are now so should

we go underweight the US market and if

we decide to how can we do it in

practice now personally I don't do this

I don't change my regional allocation

based on valuations because I think I'm

unlikely to get it timed correctly and

often when the US is expensive it stays

expensive for a long period of time but

if you're worried about us valuations

how could you go about cutting your us

exposure as a global Equity investor if

you just buy a global index of course

everything is munged in together and you

don't control the weights so an

alternative approach

is to split your Global allocation into

regions you actually don't need that

many funds in order to reproduce a

global Fund in fact you can do it with

four ETFs quite effectively you need one

for the US that would make up about 50%

of your allocation Europe including the

UK would make up 27% Emerging Markets

about 14 and Japan would make up about 9

now once you have this breakdown you can

dial regions up or down According to

which ones you think will underperform

or outperform so let's say that you

wanted to dial back your us exposure

because you think the US is expensive

and will underperform let's say you dial

it back to 40% all you do then is to

redistribute that 10% amongst the other

three funds so Europe would go from 27%

to 32% for example what I'd warn against

is removing the US altogether don't

forget that the US is expensive because

it's a really successful market and

excluding it all together I think would

be a huge mistake the US has made up

about 50% of global stock markets for

around a century so that's not unusual

so what could pop the bubble and for it

to really be a bubble of course it has

to pop it's quite hard to identify

bubbles when you're caught up in the

Euphoria it really takes a market

ShakeOut to look back and say yeah that

was a bubble so what could it be that

triggers a popping of this bubble if it

is a bubble personally I think I think

the most likely cause is going to be

something geopolitical so for example if

you look at comments from Donald Tusk

the Polish prime minister he says we

should already be preparing for war he

says that Europe is in a pre-war era I

don't want to scare anyone he says but

war is no longer a concept from the past

it is real in fact it already started

more than two years ago and here of

course he's talking about Russia's

invasion of Ukraine so could this

Ukrainian conflict escalate into the

rest of Europe it's certainly possible

and that would definitely I think pop

the US Stock Market bubble China's also

been ramping up its military spending

and of course that raises the

possibility of a conflict although

hopefully it won't come to that but if

China were to be locked out of global

markets I think that would be a really

serious problem for the global economy

and that's because of its huge size and

interconnectedness with the rest of the

global economy so if for example there

was an invasion of Taiwan

then I think that would be a huge

problem for Global markets and going

back to previous bubbles a good

old-fashioned accounting crisis is also

a Fairly reliable cause of a big stock

market selloff Enron and Worldcom were

the big ones in 2000 but of course this

time around maybe it would be something

like a tech company misstating its

earnings it doesn't even have to be

misleading on purpose it just has to be

a mistake an accounting mistake but if

invest investors have been misled that

could lead to a big re-evaluation of the

whole story about Ai and profitability

of tech and Grantham makes this point in

his most recent newsletter he says every

technological Revolution like this has

been accompanied by early massive hype

and a stock market bubble as investors

focus on the ultimate possibilities of

the technology pricing most of the very

long-term potential immediately into

current market prices and he cites the

example of Amazon and the story about

the internet in 2000 so yes the internet

was truly revolutionary and Amazon

ultimately became hugely dominant in the

internet retailing space but this came

after a huge rally initially leading up

to the 2000 bubble which then popped and

then left Amazon in the Lurch for over a

decade so it took almost 11 years to

reach its previous all-time high if we

consider inflation of course since then

the returns have been incredible for

Amazon but it did come with this huge

hangover period After People overpaid

for the stock with the early initial

enthusiasm a lot of the future up slide

was priced in very quickly and then

people paid the price as earnings didn't

keep track with that enthusiasm at least

initially so I think it's undoubtedly

true that the US is currently expensive

the question is what should we do about

it as I say personally I don't do

anything about it I've got almost all of

my wealth invested in one Global equity

fund and I'm just going to stick with it

but if you've got a lumpsum to invest

and you're nervous about investing then

I think drip feeding might not be a bad

idea at this point given that we're at

probably the top of a Euphoria phase but

if you're still in the accumulation

phase and still drip feeding into your

portfolio then I think a crash wouldn't

necessarily be a bad thing it just means

you'll get to buy stocks at a lower

valuation now don't forget our offer

from free trade who's sponsoring today's

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to free trade.io pensioncraft you'll

also find that link in the description

below and as always thank you for

listening