Market Overview – 19/01/2021

Veteran investor Jeremy Grantham believes that the long bull market in the US has now developed into a fully-fledged bubble. We have seen many investment bubbles throughout history, the most recent being the dot-com boom just over twenty years ago and the US housing market, which led to the financial crisis of 2008. So what are the signs of a bubble and what can lead to it finally bursting? Firstly, there is no all-encompassing definition of a market bubble. Jeremy Grantham points to certain exuberant investor behaviour such as the soaring price of bitcoin, new companies listing on the stock market seeing their share prices double on day one and other speculative activities. These, in his view, are warning signs that there is over-confidence building into markets. Combine that with historically high stock market valuations and you can understand these concerns.

However, there are other reasons to suggest that while stock markets may look expensive, they are not necessarily in bubble territory. Many industries have seen their profits crushed by economic lockdowns due to the Covid-19 pandemic. As vaccinations are rolled out globally, these sectors will recover and see their sales and earnings improve dramatically. We have already seen signs that investors are returning to those areas of the market in anticipation of this recovery. A broadening out of investor buying, away from the narrow focus of the FAANG stocks, for example, reduces the risk of a bubble forming.

The key risk for markets, and the thing that usually halts a dramatic rise in share prices, is central banks raising interest rates. The technology bubble burst after the US central bank, the Federal Reserve,  started to raise interest rates in March 2000. The financial crisis in 2008 took hold when unsustainably low mortgage rates in the US rose sharply leading to high levels of default.  Last week, the Fed made it very clear that it will not be raising rates any time soon. Whether markets or certain financial instruments are in bubble territory is debatable. What is clearer is that an unexpected rise in interest rates will be the most likely cause of any serious market setback.