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 being largely focused in expensive, AI-focused technology stocks, analysts say Wall Street has not yet reached bubble territory.
the Standard & Poor's 500 It has risen for 16 of the past 18 weeks and hit a new all-time closing high on Friday, but the gains were largely concentrated among the “Magnificent 7” tech giants, led by meteoric rises. Nvidia.
Meanwhile, the US Federal Reserve is expected to start cutting interest rates in June, which could provide another boon to high-growth technology stocks.
The sheer scope and narrow nature of the bull market has raised some concerns about a market bubble UPS On Wednesday, strategists drew comparisons to the late 1990s.
In January 1995, when the Fed ended a cycle of rate hikes that raised the federal funds rate to 6%, the S&P 500 began a bull run that generated more than 27% annual returns over the next five years.
Until the bubble burst spectacularly in March 2000.
“The 1990s bull run had 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,” said Banu Baweja, chief strategist at UBS, and his team. In the research note.
“Today's sectoral patterns, tightness, and correlations, are like the second phase of the market; valuations aren't far off either.”
However, despite the superficial similarities, Baweja argued that “there is no bubble ready to burst,” and pointed to notable differences in earnings, margins generated, free cash flow, IPO and M&A activity, as well as signals from the options markets.
While sector-specific enthusiasm is evident today, UBS has highlighted that it is not based solely on hype as was the case for most of the dot-com bubble, but on actual shareholder returns.
Missing item
The 10 largest companies in the S&P 500 represent about 34% of the index's total market capitalization, TS Lombard highlighted in a research note on Monday.
The research firm said this focus is justified given the excellent earnings of these companies.
“However, this means that it is difficult for the overall index to rise significantly without the participation of the technology sector, and it also means that the index is exposed to the risks specific to these companies,” said Skylar Montgomery-Koning, chief global analyst. Macro Strategist at TS Lombard.
However, the Fed's dovish pivot and resilient economic growth in recent months have enabled stock market breadth to improve, both in terms of sectors and geography, with European and Japanese indices rising to all-time highs in recent weeks.
Furthermore, Montgomery Koning said the stock's gains so far are justified by fundamentals, namely policy and growth expectations, along with a strong earnings season in the fourth quarter.
She said every stock market bubble needs three ingredients to inflate: a strong fundamental story, a compelling narrative of future growth, liquidity, leverage, or both. While the AI-led bull run meets the first two criteria, Montgomery Koning said the third criterion appears lacking.
“Liquidity remains abundant, but leverage has not yet reached worrying levels. QT has not squeezed liquidity in the US yet, as reverse repos (which absorb reserves) have declined faster than the balance sheet. In fact, “Liquidity has been increasing somewhat since the beginning of last year (there is a risk that 2024 Fed cuts will increase froth).”
“But leverage does not appear to be a concern; margin debt and open interest options suggest that speculation is not driving the rally. There has been a slight rise in margin debt but nowhere near the 2020 highs.”
Bad news?
UBS noted that the absence of a bubble does not necessarily mean the market will continue to rise, with Baweja noting that productivity growth “doesn’t look like it did in the 1990s.”
“Certainly, this could change, but today’s data on electronics and IT orders, capital spending intentions and actual capital expenditures are not at all indicative of a deepening of capital linked to enhancing productivity,” he said.
“Our measure of globalization shows it to be stalled (in fact, weak) compared to the late 1990s, when it was growing the fastest. The economy is in a late cycle today.”
UBS believes the current configuration of the economy is closest to that seen at the end of the 1990s bull run and into the early 2000s, where real disposable income growth was “weak and likely to get weaker.” Baweja suggested that these variables must start looking rosier in order for the upward trajectory to continue sustainably.
