Is US stock market in a bubble yet? Billionaire hedge fund manager Ray Dalio uncovers froth

Stock markets across the globe have seen a sharp recovery from March 2020 lows, and still continue to go strong. But the run up has prompted top investment experts rushing to figure out if there is a bubble forming in the US stock markets. Billionaire hedge fund manager Ray Dalio and global investment bank Jefferies, separately, believe there are signs of concerns. However, both do not rally behind the idea of a stock market bubble.

The recent up-move charted by equity markets comes at the time of a pandemic as countries enforce lockdowns, report negative GDP growth, unemployment numbers soar — making some believe that the stock markets are roaming in dangerous territory. But is the current situation akin to that of a stock market bubble?

Ray Dalio’s ‘bubble indicator’

Ray Dalio, the founder of Bridgewater Associates — the world’s largest hedge fund — took to LinkedIn to reveal his ‘bubble indicator’ findings. Ray Dalio used six indicators, including price relativity to traditional measures; entry of new buyers; leveraged purchases, and others, to gauge if the current situation has reached bubble territory. “In brief, the aggregate bubble gauge is around the 77th percentile today for the US stock market overall. In the bubble of 2000 and the bubble of 1929 this aggregate gauge had a 100th percentile read,” Dalio said.

Comparing the entry of new buyers into the stock markets with previous bubbles of the 1920s and the Dot-com bubble, the situation in emerging tech companies seems to be in a bubble. However, the overall market is just ‘frothy’ on that gauge. Analysing whether prices are discounting unsustainable conditions, the market shows no bubble but emerging tech stocks seem to be frothy.

There is a very big divergence in the readings across stocks. Some stocks are, by these measures, in extreme bubbles (particularly emerging technology companies), while some stocks are not in bubbles,” the billionaire fund manager said. Further, according to Dalio’s study, 5% of the top 1,000 US companies are in a bubble, which is half of the tech bubble. He added that the market action is reminiscent of the ‘Nifty Fifty’ in the early 1970s and the dot-com bubble stocks in the late 1990s.

Frothy, but no crash anticipated

Separately, Jefferies’ Microstrategy report earlier this month said that the presence of retail investors, rising levels of margin financing and liquidity suggest a growing bubble risk. Jefferies added that this risk is more for sectors proclaimed as the next growth engine but with unclear earnings visibility including EV, climate and biotech.

“US equities are in their 96-100th percentile in terms of valuations based on the 150 years of historical data, and history suggests that returns are modest to negative from current valuations levels,” the report said. However, despite this Jefferies is not calling the current market run-up a bubble. The report adds that two main triggers that could lead to a serious unwinding across equities are missing. These include an earnings collapse and a potential monetary tightening. “Other major risks include a COVID relapse, immediate US tax hikes, crippling tech regulations and retail-led financial instability. The probability of all these events is low in our view. Hence, we see the current markets as frothy and due for a correction but not a crash.”