3 Clear Signs Of A Market Bubble

Summary

• Equities have experienced significant declines recently, but quickly rebounded, and are nearing all-time highs again, indicating high investor complacency despite increasing market volatility.
• There are many good reasons to believe the overall market is currently in bubble territory.
• Equities are significantly overvalued using several historical and traditional valuation metrics, and some well-known investors are raising their cash levels substantially.
• The federal budget deficit has surged, with unsustainable fiscal policies and record-high debt-to-GDP ratios, raising concerns about future economic stability.
• We highlight what should be 3 clear signs the market is in a potential bubble in the paragraphs below.
• I am Bret Jensen, an analyst with years of experience in the biotech sector. I lead the investing group The Biotech Forum where we focus on proprietary, breaking research on biotech and biopharma stocks.

The market seems to have the attention span of my Golden Retriever, Mateo, these days. Equities have seen deep declines in the first week of trading in August and again in the opening week of September. Investors have bought the dips on both occasions, and stocks have quickly rebounded and are near all-time highs.

However, investor complacency remains high despite growing cracks in the market. Eventually, reality will set in, and we will see a substantial and longer-lasting decline across the markets. There are many signs flashing yellow at the moment. Here are three that I see that are clear indicators of what I view as a substantial market bubble:

Valuations:

Valuations across equities feel quite extreme. The S&P 500 (SP500) is trading a bit north of 22 times forward earnings within an uncertain economic environment where the jobs picture has clearly started to deteriorate. The S&P 500 trades at approximately 28 times trailing earnings. And outside the pandemic and the lockdowns (when earnings cratered and interest rates fell to near zero), that is the highest valuation of at least the last decade for this index.

On a price-to-sales ratio basis, the S&P 500 rarely has traded so dear. In fact, the only time the S&P 500 has traded for a higher price-to-sales ratio was early in 2022. This was just before a considerable move down in the market that year that saw the NASDAQ Composite Index (COMP:IND) lose approximately one-third of its value in 2022.

Investor Stalwarts Are Moving To The Sidelines:

Some famous investors are moving more money to cash. Probably the best known of which is Warren Buffett. The “Oracle of Omaha” has built up a record over $275 billion worth of cash via his investment vehicle Berkshire Hathaway Inc. (BRK.A)(BRK.B). That is up from just under $167 billion at the end of FY2023. He has notably increased this firm’s “dry powder” by disposing of large chunks of two positions he has held for many years, namely Apple Inc. (AAPL) and Bank of America Corporation (BAC).

It is easy to make a case it made sense to lighten up substantially in both of these well-known names. Apple trades at north of 32 times forward earnings, as well as its highest price-to-sales ratio for at least the last 15 years. Bank of America has traded toward the top quarter of its price-to-book (a traditional valuation metric for banks) ratio range over the past 15 years.

Evidently, the stock of Berkshire Hathaway is no bargain either at current trading levels either. At least, that is what might be gleaned from Ajit Jain selling just over half his holdings in Berkshire recently. Mr. Jain is the long-term head of the insurance business and Vice Chairman of the company. Berkshire also trades at its highest price-to-book ratio for at least 15 years.

In addition, famed billionaire hedge fund manager and owner of the New York Mets Steve Cohen is rumored to be soon returning billions of dollars to its investors via his investment fund Point72 Asset. Management will be forgoing tens of millions of dollars of potential fees. It is the first time Point72, formed a decade ago, has contemplated just a move. The fund holds some $25 billion in investments.

The 800lb Gorilla In The Room:

The federal deficit in August came in at $380 billion last week. This was far above the $285.7 billion expected. This was also up from $244 billion. Receipts came in at $306 billion, some $24 billion less than the prior month. Outlays rose more than $90 billion from the prior and were just under $687 billion. That leaves the budget deficit at $1.9 billion for the first 11 months of the federal government’s fiscal year, a 24% rise from FY2023.

With the federal debt-to-GDP ratio already at record levels in U.S. history, it is difficult to believe running a nearly 7% of GDP annual fiscal deficit is sustainable. The fact these deficits are happening during an economic expansion is even more concerning. What happens when the country enters a recession?

The interest expense on the debt in August was an astounding $92.3 billion. Meaning, at an annual run rate, the country is now spending north of $1 trillion to service its massive and growing debt burn, which is at $35.3 trillion and growing rapidly. It is now the biggest line item in the budget. Larger than defense outlays or social security. And that doesn’t include at least $80 trillion worth of unfunded entitlement liabilities on top of the federal debt.

At some point, this debt will be an existential threat to the financial condition of the U.S. No one knows when that “day of reckoning” will happen, however. What one can project given this massive debt load is that the days of ZIRP are gone forever, and interest rates will stay higher than they otherwise would, given the need to constantly refinance existing and new federal debt.

The almost neurotic tenor of trading over the past six weeks, which have seen huge up and down weeks and large fluctuations in volatility, could be pointing to a significant inflection point coming up in the markets. This could result in equities rising to even more extreme valuations and hitting new all-time highs. The chances of a significant pullback also seem elevated. Personally, I am leaning substantially towards the latter scenario given the current valuation metrics equities are sporting within an uncertain economic environment.

This article was originally published on this site

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