Is a financial market bubble brewing?
Financial markets are riding a wave of bullish enthusiasm, with stocks, cryptocurrencies, and other speculative assets soaring to new heights. Fueled by optimism around cooling inflation, robust corporate earnings, and the transformative potential of artificial intelligence (AI), the rally has pushed valuations to levels some are saying is reminiscent of the 1999/2000 dot-com era.
Beneath the surface, some anecdotal warning signs suggest a potential bubble is forming. As bubbles form, acknowledging and understanding these signals is crucial to navigating markets that are increasingly driven by sentiment rather than fundamentals.
Overvaluation?
The S&P 500 is trading at 22 times forward earnings, significantly above its historical average of just under 18 times. The inverse of the price-to-earnings (P/E), which is the earnings yield, is at 4.5 per cent – near its lowest level relative to long-term real yields since the tech bubble of the early 2000s.
Over the past month, stock prices have outpaced earnings growth, pushing valuations to previous highs. While valuations are a notoriously poor timing indicator, they serve as a useful gauge of market sentiment and expectations.
As Morgan Stanley Investment Management’s chief investment officer, Jim Caron, was reported as saying, “If prices run away from earnings, the market is basically saying we’re going to grow into these valuations.” The optimism assumes sustained or uninterrupted growth, but history shows that interruptions occur, and therefore, such expectations can produce sharp corrections when reality falls short.
Figure 1. S&P 500 P/Es through time and where we are now
Source: Real Investment Advice
It’s worth noting that today’s S&P 500 is of higher quality than in 1999, and is supported by record corporate buybacks, which may justify elevated valuations. But the catch is establishing how much higher is justified.
The concentration of gains should raise some concern. Nearly half of the S&P 500’s earnings growth this year has come from the tech sector, making the index vulnerable to any change in sentiment in this thematic.
Meanwhile, the Equal-Weighted S&P 500 recently hit a new all-time high, suggesting some broadening of the rally, but the market’s still reliant on a handful of mega-cap tech and artificial intelligence (AI) related stocks.
Penny stocks and leveraged Exchange Traded Funds (ETFs)
Speculative activity is surging across multiple asset classes, a classic sign of market exuberance. Assets under management in leveraged ETFs, which amplify market exposure and risk, have reached a record US$135 billion. Short-dated options trading, known for its high-risk, high-reward profile, has also skyrocketed, reflecting a market driven by sentiment over fundamentals.
Penny stock trading, historically a playground for retail investors, has doubled since pre-2020 levels, now accounting for over a quarter of total trading volumes. This surge, amplified by the trading of fractional shares and options, reflects a retail-driven pursuit of quick gains. And while they wouldn’t do it if they thought the market was going to crash any time soon, their activity and behaviour suggest a countdown has commenced.
The ARK Innovation ETF, which holds speculative, often unprofitable companies, has climbed more than 36 per cent year-to-date, signalling renewed appetite for high-risk investments.
Cryptocurrencies are also riding the wave. While bitcoin prices are surging, it’s the more than 60 publicly traded companies that are proposing to stockpile the cryptocurrency, effectively turning their shares into leveraged bets on its value, that concerns me. This reminds me of the Special Purpose Acquisition Company (SPAC) boom during COVID-19 and the subsequent bust.
Figure 2. Bitcoin and the Nasdaq: does correlation reveal froth?
Source: Topdown Charts, LSEG
Bespoke Investment Group recently published some analysis that highlighted the disproportionate gains in unprofitable companies. Of the 33 Russell 3000 stocks that tripled in price since the market bottom in April, only six were profitable last year.
Meanwhile, the 858 money-losing companies in the Russell 3000 index rallied 36 per cent on average, compared to just 16 per cent for the 500 stocks with the lowest price-to-earnings ratios.
Companies like nLight, Aeva Tech, and Ouster – unprofitable firms with snazzy names – have seen share prices soar by at least 200 per cent since April 9, driven by momentum rather than fundamentals. And stocks with heavy short interest, often low-quality firms, have experienced “face-ripping” gains fuelled by social media ‘memes’ that squeeze short sellers, forcing them to unwind positions and sustaining upward momentum even after initial buying pressure subsides.
Tech and AI hype: echoes of the Dot-Com bubble?
The tech sector, particularly AI-driven companies like Nvidia, is at the heart of the rally. Nvidia’s entry into the US$4 trillion club, with its stock price lauded even by public figures like U.S. President Trump, underlines the sector’s dominance.
However, and this is a somewhat tired warning, the concentration raises red flags. Some analysts suggest the current tech rally mirrors the dot-com bubble, when hype around companies like Cisco – then trading at 200 times forward earnings – drove markets to unsustainable heights. While Nvidia’s current 40 times forward earnings is backed by strong profit growth, the broader market’s reliance on tech giants makes it vulnerable to any sector-specific setbacks.
And while I believe valuations can get out of hand, the current crop of market leading tech names are wildly profitable, hugely cash generative and produce real products that people and companies are paying for.
Of course, the narrative that “AI changes everything” echoes past market manias, such as “the internet changes everything” in the 1990s or “real estate never goes down” in 2007.
Private markets
Venture capital markets are also showing signs of fizz. Median U.S. Venture Capital (VC) deal valuations in 2025 have surpassed the 2020-2022 peak, according to PitchBook, creating a glut of overvalued startups.
Meanwhile, Axios Pro Rata’s Dan Primack notes that venture capitalists overspent and overvalued companies during the zero-interest-rate policy (ZIRP) era, and 2025 is looking like a replay, with stratospheric valuations for early-stage firms. This trend mirrors the public market’s exuberance and suggests a broader speculative mindset.
Anecdotal evidence of exuberance
Anecdotal signs of market froth are hard to ignore. Jeff Bezos’s €40-50 million Venice wedding and subsequent sale of US$665 million in Amazon stock, Meta’s US$200 million+ salaries for top AI talent, and the €8.6 million purchase of an original Hermes Birkin handbag at auction reflect a culture of extravagant spending.
Market complacency and seasonal risks
Market complacency is another concerning signal. The Volitality Index (VIX) has fallen below 15, and the market has journeyed 22 trading days without a 1 per ent move up or down – an unusually quiet period.
Historically, August to October is the most volatile time of year for markets, with the worst returns. This year, potential catalysts for volatility include debates over Federal Reserve policy, the risk of resurgent inflation, tariff uncertainties, geopolitical tensions, and a shift in sentiment toward tech valuations.
Are elevated valuations justified?
As I noted a moment ago, some analysts argue that today’s valuations are defensible. Unlike the dot-com era, today’s tech giants have substantial earnings and cash flow. However, the concentration of gains in tech, the surge in speculative investments, and the dismissal of risks like tariffs raise questions about sustainability.
By way of example, Australia’s ASX 200 companies are expected to report a 1.7 per cent profit drop this financial year, and down 18 per ent from peak estimates. Gains don’t seem to reflect profit growth. By way of example, the shares of the Commonwealth Bank of Australia (CBA) are up 40 per cent over the past year, despite a modest 2 per cent increase in interim profit.
Trump’s tariffs could settle at 15-20 per cent
Optimism has led investors to ignore or disregard potential headwinds, such as tariffs. In April, tariffs were seen as a grave threat to corporate earnings; today, markets are trading as if they pose no risk. This shift in sentiment, where prices rise regardless of news, is a hallmark of speculative excess and doesn’t last.
The bottom line
The financial markets are at a critical juncture. Bullish sentiment, driven by cooling inflation, strong tech earnings, and AI optimism, has propelled stocks to record highs.
In the absence of a disruption to these trends, there’s no reason to expect a correction.
However, overvaluation, speculative excess, and complacency signal a potential bubble, which inflates prices such that even an investment in a high quality growth company can produce a poor return.
The dominance of tech, the surge in prices for unprofitable companies, and anecdotal signs of exuberance echo past market manias, while seasonal volatility and macroeconomic risks are possibilities.
The U.S. and Australian earnings seasons will reveal whether fundamentals are enough to support the lofty valuations now a reality. How long the market rides on “vibes” alone is anyone’s guess. History however suggests vibes aren’t enough. Overconfidence can lead to sharp corrections if reality disappoints or disrupts.
Markets can remain overbought for longer than many expect because greed tends to outlast fear, but the current boom may be like the many before it and precede a storm.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
