The stock market’s performance seems disconnected from the dire economic environment. However, given that earnings are temporarily depressed, interest rates have dropped, massive stimulus measures support markets, and in our view there is similarity to the 2009 recovery, our Head of Global Multi-Asset Sébastien Page does not believe that stocks are in a bubble.
The stock market looks divorced from the real economy. Does this mean that stocks are in a bubble? I don’t think so. There is significant pain in the real economy—2020 U.S. GDP expected at -8%, 2020 earnings -23%, unemployment 10%, 20 million people unemployed. How can the stock market be up 55% from the bottom?
The simple answer is that stocks don’t price in current conditions. They anticipate future earnings. Also, we need some perspective on this 55% number. The S&P 500 is only up 6% year-to-date and the Russell Value Index is down 10% year-to-date. Only 38% of the S&P 500 is making new highs relative to pre-pandemic levels. Also the S&P doesn’t represent the entire economy, it represents 500 large companies, some of which have digital business models that have thrived during COVID.
So, I don’t think stocks are in a bubble for four reasons. First, earnings are temporarily depressed, including some companies losing money. Markets are trading off 2021 and beyond earnings. Stocks don’t price off current economic conditions. They price off anticipated conditions and anticipated earnings.
Second, rates have come down 150 basis points, which justifies higher valuations by discounting the cash flows. Third, the size of the stimulus has been unprecedented, representing as much as 40/45% of total world market cap.
If we adjust for the level of rates, we are actually following the path of the 2009 recovery quite closely. There are two stages to a recovery: first, multiples expand because earnings are depressed, and second, earnings renormalize.
By the way, on the disruptors, these are extremely profitable companies with highly scalable business models. There is some speculative buying in the market, but look at the disruptors’ cash flow yield and subtract the risk free rate, and you’ll find that they look fairly cheap—especially relative to the tech bubble of 2000.
So, no we are not in a bubble, stocks are perhaps fully priced. At the moment, we are neutral between stocks and bonds from a tactical six-18 month horizon perspective.