Are stocks in bubble territory? Analysts are not convinced

With stock market valuations at historically high levels despite the ever-present shadow of the coronavirus pandemic, speculation about a market bubble has been rekindled.

The rollout of Covid-19 vaccines and associated hopes for imminent economic recovery, along with unprecedented fiscal and monetary support from governments and central banks around the world, has driven equity markets beyond or close to record highs in recent weeks…

Going into Wednesday’s trading session, the Dow Jones Industrial Average was up 67% from its March lows, while the S&P 500 was up 70% and the Nasdaq 92%.

Although the distribution of vaccines is underway in many major economies, caseloads are rising amid mutated strains of the virus, forcing a number of countries to reintroduce stringent lockdown measures.

Jeremy Grantham, long-term investment strategist and co-founder of GMO, said in a note Tuesday that the protracted market bull run which began in 2009 had “matured into a fully-fledged epic bubble.”

“Featuring extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behavior, I believe this event will be recorded as one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000,” Grantham said.

Three reasons ‘bubble’ worries are overdone

Grantham highlighted that the stock market price-to-earnings ratio is in the top few percentiles historically while economic growth is among the bottom percentiles. “This is completely without precedent and may even be a better measure of speculative intensity than any SPAC (special purpose acquisition company),” he said.

Earlier this week, Wall Street titan Carl Icahn also cautioned that the kind of “wild rallies” seen in markets of late inevitably “hit a wall and go into a major painful correction.”

“Nobody can predict when it will happen, but when that does happen, look out below,” Icahn added.

However, many analysts are not convinced that the new lockdown measures represent a fundamental deterioration in the economic outlook, indicating some solace for equities.

Mark Haefele, chief investment officer at UBS Global Wealth Management, said Wednesday that the medium-term outlook for economic and earnings growth remains positive. UBS expects the global economy to expand by 6.3% in 2021 after a contraction of around 3.5% in 2020.

“After strong earnings surprises over the past two quarters, including third-quarter earnings in the U.S. being 40% higher than in the prior quarter, the outlook for corporate earnings in 2021 is also encouraging,” he added.

Haefele offered two further reasons why concerns about a bubble are “overdone,” the first being that valuations are not necessarily indicative of euphoria given the macroeconomic context.

“At 6%, the equity risk premium for global equities is above the average since 1998 of around 4%, indicating that stocks remain attractive relative to bonds,” he said.

Equity risk premium is the additional return an investor earns by investing in stocks rather…

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