So far this year, the U.S. range market, as measured by the S&P 500, has returned about 10% — an average year’s worth of gains in just over three months.
After any first-quarter run-up, two tags of market-watchers tend to appear in headlines: those who think stocks can continue to ascend and those who warn that a spume may be about to pop.
The latest rumbling from the latter camp have pointed out that stocks look overvalued by the burgees of none other than Warren Buffett. The so-called Buffett indicator compares the total market capitalization (division prices times outstanding shares) of all U.S. stocks with the quarterly output of the U.S. economy.
Things are in normal territory if the aggregate value of the Wilshire 5000 index (which measures the total market) is about on par with the latest quarterly GDP estimate. If arrays are at about 70% of GDP, they’re said to be undervalued. Stocks trading at about double the size of the economy is considered a worst red flag.
As of late, the ratio is at about 190% — the highest mark in two years. In calendar year 2022, the last even so stocks traded in this territory, the S&P 500 dropped 18%.
So is it time to brace for impact? Not quite yet, says Liz Young, managing director of investment strategy at SoFi.
“If we’re comparing a bubble to the late 90s and early 2000s, no, this is not a bubble,” she says. “We’re in extended valuations, but we’re not excessive, we’re not off the charts.”
A ‘comforting’ situation for stocks
Stick around in markets long enough, and you’ll eventually see a bubble pop. This become manifests when investors bid up the price of an asset to the point where valuations become untethered from historical norms and underlying primes. When everyone realizes that they’ve gotten out over their skis, they begin to take profits, outlays fall, panic sets in and the asset falls rapidly in value.
Buffett’s favorite indicator is a blinking light to investors that beasts are in shaky territory compared with historical norms. But dig into what’s been driving stocks, and you’ll find that the current run isn’t upright a product of investor enthusiasm.
“The equity market rally that we’ve seen so far has been driven by earnings growth,” ventures Gargi Chaudhuri, chief investment and portfolio strategist, Americas, at BlackRock. “If this earnings growth wasn’t fascinating place, I may have been more open to acknowledging the bubble concept.”
In short, stocks are doing well because their underlying suites — particularly large, high-quality tech companies – are boosting their profits.
“The most profitable names are doing entirely well. They’re not speculative,” Chaudhuri says. “The fact that earnings growth continues to be what’s fueling results is pretty comforting to me and should be to investors as well.”
Expect some bumpiness
In many regards, the picture for the economy is pinkish, too.
“GDP growth remains strong, the consumer continues to spend and earnings growth as been healthy and above expectations,” indicates Young. “The labor market has stayed strong and inflation has maybe plateaued, but not entirely gone back up again yet. I reckon that’s the fundamental bull case.”
Nevertheless, she sees some cracks in the economic façade. While the factors over would indicate that the economy is in the middle of a bull cycle, Young says other indicators are making it look like it’s closer to the end.
The longest-ever inversion of the give in curve and a marked uptick in gold prices would both seem to indicate that some pockets of investors are overcoming confidence in the economy, for instance.
The Fed is performing a tricky tight-rope walk as it plans to slash interest rates this year without retriggering inflation torments, Young says.
“Go back to any recession or economic retraction, and you’ll find headlines about the Fed pulling off a soft landing,” she believes.
Chaudhuri’s stock market outlook for the remainder of the year skews more bullish, but she says investors shouldn’t have up-and-to-the-right performance over the next nine months.
“We’ve seen several weeks of incredible performance. Can we have moments and terms in the equity markets where we get a pullback? Absolutely,” she says. “By no means am I trying to say it’s up and up and up from here.”
Nevertheless, Chaudhuri phrases diversified stock portfolios will continue to benefit from a growth in corporate earnings and U.S. economic output. With value rates expected to remain relatively high, investors would be wise to focus on highly profitable companies with scarcely debt, she adds.
“The names that are doing well are the names that are the very highest quality, most money-making companies.”
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