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For Professional Clients and, in Switzerland, for Qualified Investors only. In Israel for Sophisticated Investors only.
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IDEAS AND KNOWLEDGE TO INSPIRE YOUR INVESTMENTS THINKING
18 February 2021

Is the US equity market storing up trouble?

There are many traits that characterise a market bubble. The most commonly cited is valuation – it is widely accepted that all prior ‘bubble’ markets have been extremely overvalued. For example, Robert Shiller’s cyclically adjusted price-to-earnings (CAPE) ratio indicates US stocks are nearly as overpriced as they were during the 2000 technology bubble.

 

Another dependable feature of a late-stage equity-market bubble is rampant speculative behaviour, particularly on the part of non-professional investors, as the siren call of rising prices draws in the masses and stocks become the talk of the town. Today we see trading of options by retail investors has exploded. The volume of small purchases (of less than 10 contracts) of call options on US equities has increased eight-fold compared to 2019, a year that was already well above the long-run average.

 

In the latter stages of a bubble, the combination of lofty valuations and speculative behaviour often ensures investment banks are kept busy helping companies tap the capital markets for finance. Last year was a record year for corporate-debt issuance and there were 480 initial public offerings (IPOs) – eclipsing the 406 IPOs of 2000. A remarkable 248 of these IPOs were US special purpose acquisition companies (SPACs) – shell companies created for the special purpose of merging with some private company to take that company public faster than could have been the case with a normal IPO process.

 

Taking this all together, those advancing the argument that the US market is currently in a bubble could have a credible case.

 

The Real Return team at Newton.

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