Traders work on the floor during morning trading at the New York Stock Exchange on March 6, 2024.
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Despite the U.S. market rally’s heavy concentration on expensive, AI-focused tech stocks, Wall Street is not yet in bubble territory, analysts say.
The S&P 500 has risen in 16 of the last 18 weeks and hit a new all-time closing high on Friday, but the gains were heavily concentrated in the so-called “Magnificent 7” tech giants, led by exploding companies Nvidia.
Meanwhile, the Federal Reserve is expected to begin cutting interest rates in June, potentially providing another boon for high-growth tech stocks.
The sheer scale and limited nature of the bull run has raised some concerns about a market bubble UBS Strategists on Wednesday drew comparisons to the late 1990s.
In January 1995, as the Fed ended a cycle of interest rate hikes that had pushed the federal funds rate to 6%, the S&P 500 began an upward trend that delivered an annual return of over 27% over the next five-plus years.
Until the bubble burst spectacularly in March 2000.
“The 1990s bull market went through two phases: a broad, steady rise from early 1995 to mid-1998 and then a narrower, more explosive phase from late 1998 to early 2000,” UBS chief strategist Bhanu Baweja and his team said in the research report.
“Today’s sectoral patterns, tightness and correlations are similar to those of the second phase of the market; The ratings aren’t far off either.”
But despite the superficial similarities, Baweja argued that “there is no bubble that is about to burst,” pointing to notable differences in earnings, realized margins, free cash flow, IPO and M&A activity, and options market signals.
While industry-specific enthusiasm is evident today, UBS emphasized that it is not based solely on hype, as was the case with much of the dot-com bubble, but on actual shareholder returns.
The missing ingredient
The top 10 companies in the S&P 500 account for about 34% of the index’s total market capitalization, TS Lombard highlighted in a research note on Monday.
The research firm argued that this concentration was justified given these companies’ excellent earnings.
“However, this means that it is difficult for the overall index to rise significantly without participation from the technology sector, and it also means that the index is vulnerable to the risks inherent in these companies,” said Skylar Montgomery Koning, senior global Macro strategist at TS Lombard.
But the Fed’s dovish stance and robust economic growth in recent months have seen the stock market’s breadth improve in terms of both sectors and geography, with both European and Japanese indices hitting all-time highs in recent weeks achieved.
Additionally, Montgomery Koning argued that equity gains to date were justified by fundamentals, namely policy and growth prospects, as well as a strong fourth-quarter earnings season.
She said that every stock market bubble needs three ingredients to inflate: a solid fundamental story, a compelling narrative for future growth and liquidity, leverage, or both. While the AI-driven bull run meets the first two criteria, Montgomery Koning said the third appears to be missing.
“Liquidity is still plentiful, but debt has not yet reached worrying levels. QT has not resulted in a decline in liquidity in the US so far as reverse repos (which absorb reserves) have declined faster than the balance sheet. “In fact, liquidity has increased somewhat since the beginning of last year (there is a risk that Fed rate cuts in 2024 will add to the froth),” she said.
“But the debt level doesn’t seem to be a concern. Margin debt and open positions in options suggest it is not speculation driving the rally. There was a slight increase in margin debt, but nowhere near the 2020 highs.”
The bad news?
The absence of a bubble does not necessarily mean the market will continue to grow, UBS stressed, and Baweja noted that productivity growth “no longer looks like it did in the 1990s.”
“Sure, that may change, but today’s data on electronics and information technology orders, capital expenditure intentions and actual capital expenditures do not at all indicate the capital deepening associated with productivity improvement,” he said.
“Our measure of globalization shows that it is stalling (actually weakening) compared to the late 1990s, when it was growing at its fastest pace. The economy is in a late phase today.”
UBS believes the current economic scenario is closest to that at the end of the 1990s and early 2000s, with real disposable income growth “weak and likely to become weaker.” Baweja said these variables need to start looking rosier for the bull run to be sustained.
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2024-03-07 12:29:04
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