Boom or bubble? Navigating today’s soaring stock market
In this week’s video insight, I explore whether we’re in the midst of a genuine market boom – or drifting into bubble territory. While strong earnings, high margins, and a pause in rate hikes have fuelled the rally, valuations are stretching well beyond historical norms.
Speculation is on the rise, and many unprofitable stocks are soaring. That’s why I’m urging investors to stay grounded: focus on fundamentals, stick with quality businesses, diversify, and keep a close eye on liquidity and macro risks.
Transcript:
Hi, everyone, I’m Roger Montgomery, and welcome to this week’s video insight.
Today, we’re diving into the state of the stock market – booms that build wealth and bubbles that risk it all. Markets are soaring, but there are warning signs, so let’s unpack what’s driving this rally, and decide whether the red flags should be taken seriously.
But first, boom versus a bubble? What’s the difference?
A boom is when stock prices climb on the sustaining influence of strong fundamentals such as solid earnings, and economic growth amid deflation. A bubble, though, is when prices soar beyond fundamentals. Fuelled by speculation and irrational exuberance price keep going up even if the fundamentals have stopped doing so.
The co-founder of GMO, and perma-bear Jeremy Grantham, once noted in a Barron’s interview: “There are two good standards for a bubble… one is boring statistics, and the other is an exciting behavioural frenzy.”
The market price-to-earnings (P/E) ratio typically spends 95 per cent of its time within two standard deviations of its mean, so we are in old-fashioned bubble territory when the market is more than two standard deviations beyond its mean.
During the internet bubble of 1999/early 2000 the market P/E hit three standard deviations for the S&P 500 and just before COVID it hit two standard deviations, as it did right before Trump’s April Liberation Day Tariff announcement. Today, the S&P500 P/E is again right on the two standard deviations band above its long-run mean.
History suggests that extremes rarely end well. Of course, many will say this time is different. When I was at Merril Lynch in 1999 I remember the U.S. analysts published a massive tome suggesting that the internet stocks of the day were so transformative that “almost any price can be paid”.
Today, analysts will say markets have evolved, margins are higher, companies can generate profits off fewer assets, they have less debt and there are more growth stocks. All of that is true, and eventually that narrative will draw in all the buyers that were ever going to believe it. Next the rising prices will attract those who fear missing out on the rising prices. Eventually, there are no new buyers and so there is nobody left to sell shares to. And at that point, lower prices are explored by sellers…So even when times are different, prices can become…too different.
When valuations exceed two standard deviations above their historical averages the risk of below-average returns rises sharply.
The current rally is underpinned by strong corporate earnings, accommodative monetary policy, and a nascent speculative optimism. Earnings margins in Q1 2025 hit 11.84 per cent, well above the historical average of 8.51 per cent, while consensus estimates for single-digit growth this year have kept stock prices buoyant. Additionally, the Federal Reserve’s pause in rate hikes has eased liquidity concerns, even as the policy rate remains elevated at 4.50 per cent.
But here’s some things to consider. Speculation is ramping up if not already rampant – 33 Russell 3000 stocks have tripled since April, but only six of them were profitable last year.
I don’t think this is the dot-com bubble, when Cisco hit 200 times earnings before crashing. Nvidia’s trading at 40 times earnings and its generating real profits and double digit growth, so it’s not as extreme – but the “AI changes everything” hype sounds familiar.
Blind confidence can blind us to the risks. So, how do you navigate this? First, focus on fundamentals –stick to quality…companies with strong earnings and reasonable valuations. Trim winners and diversify across sectors and asset classes to avoid over-reliance on any one sector or asset class. And stay connected rather than distracted – watch central bank liquidity measures and note that earnings season and tariffs could shake things up, especially in the typically volatile August-to-October window.
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.
