Bulls vs. bears – bubble brewing or rally building?
In this week’s video insight I explore signs that today’s bull market may be showing signs of a bubble. The bulls point to two key observations supporting the markets’s strength. First, market breadth is widening – with more stocks joining the rally. And second, earnings momentum is improving with over 80 per cent of U.S. companies seeing positive earnings revisions.
While these observations appear supportive on the surface, they can also be read as signs of a maturing bull market edging towards a bubble.
Transcript:
We have recently alerted investors to the possibility that the maturing bull market, which began at the end of 2022, is showing some signs of morphing into a bubble. Anecdotal evidence includes multiple profitless companies rising 300 per cent, more than 60 U.S. listed companies commencing Bitcoin reserve strategies – reminiscent of the Special Purpose Acquisition Companies or “SPAC” craze of 2020 and 2021 – elevated margin debt, extreme concentration among artificial intelligence (AI) names as well – as extended valuations in them – AND at the same time an MIT report revealed that 95 per cent of adopted business AI projects have failed, could arguably all point to bubble-like conditions.
Perhaps this is all big picture stuff and we should be looking a little more closely at other indications. If so, what are the bulls pointing to, that justifies the view the market should continue rising?
Well, the first observation is that market ‘breadth’ (the number of company stocks participating in the rally) is increasing. Market declines tend to (but not always) follow a period of declining breadth. And the reverse is occurring right now. More stocks are joining the rally. This indicator rising however isn’t a reliable buy signal. More reliable is to add to your investments in equities when breadth is on it’s knees, when the breadth indicator is below 25 per cent. Be greedy when others are fearful.
The second piece of evidence the bulls point to is that more than 80 per cent of U.S. companies are seeing positive earnings revisions. With more than 95 per cent of S&P 500 companies having reported their second-quarter results, corporate America has beaten expectations. The S&P 500 had a relatively low bar to clear of just 4.9 per cent earnings growth expected for the quarter, but America’s largest 500 companies are tracking towards 11 per cent year-over-year growth – more than double the level expected at the start of earnings season on July 1.
Another pointer for the bulls is the emerging strength in microcap, frontier and emerging market stocks. They generally have lower levels of liquidity and higher volatility, and that’s been keeping investors sidelined for several years…but now it appears confidence is returning.
But, as you have probably already noticed some of these indicators could just as easily be argued to be signs of the market boom’s late stage.
Every bubble in modern market history has been based on a thematic or a narrative. In the past, it’s either the internet or real estate. Whatever it is, investors and proponents see it as a source of unlimited earnings growth. That theme today is unquestionably AI technology. But this time, valuations aren’t as extreme. Sure P/Es are high but they’re not as high as during past bubbles. And this time, many of the AI leaders are also generating billions in quarterly revenue. This isn’t vapourware.
And what about volatility? There’s little doubt, with Trump at the helm, we can expect the unexpected between now and 2028 – and maybe beyond. More immediately as you can see in this chart, the Vix tends to rise between now and November. Not always but mostly.
As always, we will only know if this is a bubble on the other side of it. Some of you will subscribe to the view that it’s better to be six months early than six minutes late. If that’s you, then all you need to do is undertake your scheduled portfolio rebalance now and bring your weightings across asset classes back to their initial weights. For some, it’s enough that Warren Buffett is holding on to record cash and for others…well, they’re just happy to be earning 7-9 per cent a year in private credit funds without any exposure to public markets.
My view is, if you have a framework and a process for investing, it doesn’t matter what you think the market will do. Your investing strategy and process – tied as they are to your risk tolerance and financial personality – will help you navigate whatever the markets or Donald Trump serve up.
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.
