With global markets at all-time highs, it is natural to wonder if the market is in a bubble and if it would be a good time to take profits.
Two contrasting takes on this question were recently published.
Jeremy Grantham of asset manager GMO believes that the US market is overvalued.
www.gmo.com/europe/research-library/the-great-paradox-of-the-u.s.-market_viewpoints
The valuation of the US market can be assessed with the Shiller P/E ratio, which currently sits at 34.
www.multpl.com/shiller-pe
Grantham warns that there has never been a sustained rally starting from a 34 Shiller P/E. Higher valuations were only reached in the tech bubble in 1999-2000 (the Shiller P/E peaked at 43) and, before that, in the Japanese stock market bubble in the late 1980s (when the Shiller P/E reached almost 100).
Both of those episodes ended badly.
Because of the high valuations of US stocks, Grantham prefers non-US markets, and the Value style within those markets.
A more optimistic take on the US market is offered by Ray Dalio, a hedge fund manager, who asks if US stocks are in a bubble.
www.linkedin.com/pulse/we-stock-market-bubble-ray-dalio-zpdre
Dalio argues that the market is only somewhat expensive, and much cheaper than during the tech bubble 25 years ago. Not too many new buyers have recently entered the market, sentiment is neutral, leverage is low, and companies are not investing heavily. Overall, the market doesn’t look very bubbly.
Where do I stand in this debate?
I would not like to bet against the market at this point.
I agree with Grantham that the US market is expensive and that, as a result, returns for passive investors in the US will be low. But valuations can always become more expensive before they revert lower.
I also agree with Dalio that the traditional signs of a speculative market top are not yet in place.
I thus follow economic momentum, which remains positive, and so stay long economically-sensitive sectors such as Banks and Energy.
I would turn more cautious if economic momentum turned negative, sentiment became euphoric, or valuations went more clearly into bubble territory.
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