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UBS strategists estimate that six out of eight signs of a stock market bubble are already showing.
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Hype around generative AI has pushed stock prices to record highs, sparking fears of a bubble.
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Current conditions reflect those of 1997, not 1999, suggesting that a bubble may soon be forming.
There have been we talk a lot about the stock market bubble over the past year, as hype around generative artificial intelligence has pushed stock prices to record highs.
In a recent UBS note, strategist Andrew Garthwaite laid out the eight warning signs of a stock market bubble – and according to Garthwaite, six of them are already flashing.
This means that the stock market is not yet in a bubble, but it could be soon.
“The upside risk is that we end up in a bubble. If we are in such a situation, then we think it is similar to 1997 and not 1999,” Garthwaite said.
That’s important because stock market bubbles often result in a painful 80% decline once they burst, but Garthwaite says we’re not there yet.
“We only invest for the bubble thesis if it is 1997 and not 1999 (which we think it is),” Garthwaite said.
These are the eight warning signs of a stock market bubble, according to Garthwaite.
1. The end of a structural bull market – Flashed
“Bubbles tend to occur when historical stock returns have been very high relative to bond returns and investors therefore extrapolate historical returns to predict future returns – when in fact future returns, as the ERP shows, are significantly below their standards,” Garthwaite said.
2. When profits are under pressure – Flashed
While the S&P 500’s earnings have exploded over the past year, there is another measure of corporate profits that should be monitored by investors.
NIPA profits measure the profitability of all companies, including private companies, and when these diverge with the profits of publicly traded companies, investors should take note.
“We can see this if we look at the TMT period, during which NIPA profits fell while stock market profits rose. The same was true in Japan in the late 1980s,” Garthwaite said.
3. Large loss of width – Flashé
When the stock market is extremely concentrated in a handful of companies that generate the bulk of the gains, it’s a sign of low magnitude.
With record concentration in large-cap technology stocks, this is exactly what has happened as the median stock fails to generate strong returns.
“We can see this especially if we look at the line of downward progress against the S&P 500 over the TMT period,” Garthwaite said.
4. A gap of 25 years is needed compared to the previous bubble – Flashé
“This allows a whole group of investors to believe that ‘it’s different this time’ and develop theories that stocks should be subject to a structurally inferior ERP,” Garthwaite said.
5. At a 25-year gap from the previous bubble – Flashed
“This story revolves around domination…
