Asset allocation in a US stock market bubble

Status
Not open for further replies.
F

Flybytheseat

Registered User
Messages
449
With the US Stock markets currently clearly in a bubble (CAPE (Schiller P/E ratio) at nearly 32 against a historical average of 16.8) and with Trump elected the financial outlook for the US is poor with inflation / stagflation extremely likely over Trump's term. Interest rates will rise, the Fed will continue to print money generating high inflation, asset prices will rise (equities, US Real Estate), crypto will continue up to the ponzi scheme high until it's bubble bursts and the ponzi scheme ends with the bitcoin falling to earth.

Where macroeconomically should people invest if they believe the above to be likely ? You can't be in cash or long term bonds as you'll be wiped out by inflation/ interest rate rises. Will the dollar loose its reference currency designation in the next 10 years with record US national debt and noone willing to buy US government bonds / debt for fear of an inevitable default?

Most multi asset pension funds are heavily US focused with US equities making up 60-80% of their assets. US stocks are clearly overpriced so where can you put your equity investments (Emerging Markets (BRIC, Asia ? ), European Stock (not exactly showing any signs of growth), precious metals (gold/silver/platinum), other commodities, REITs, Crypto (if you've lost all sense)... ?
 
Last edited:
The sky didn't fall the last time Trump was elected, it won't fall this time either.

The primary differences between the two parties in the US is primarily form rather than substance. That's also true of economic policy.

The stock markets are predicted by Goldman Sachs to average 3% growth a year. That will just bring stock prices in line with the long term average.

Calm.
 
Last edited by a moderator:
SquirrelChaser said:
The sky didn't fall the last time Trump was elected, it won't fall this time either.
Click to expand...
We'll have to see if Trump's behaviour is the same this time round. What he's saying and who he's appointing suggest it'll be a bit crazier this time.

As to the question of the OP, Trump's term is only a few years. Investments will recover.
 
Let's not get into a debate about whether it currently is or is not in a bubble right now and focus instead on
Assuming you think it is in a bubble - or assuming you think the market is heading down
What should you do to your asset allocation?


One school of thought is that you do nothing. You should have a long term plan and you should stick with it.
The main thrust of that argument is that trying to time the market is foolish - it's difficult because you have to get 2 timing decisions correct (getting out and then getting back in), and the overwhelming evidence is that the vast vast amount of people do not beat the market when attempting it.

I agree with that particular argument, but my own approach has been to keep 90-95% of my allocation just as I normally would and move 5 to 10% to cash or bonds. Although I have to be honest and say while I have often got the timing right for getting out, I always miss the timing for getting back in, so overall this approach has probably not given me any advantage.
 
Of course I have always been in the accumulation or growth phase of investing.
Maybe the argument is different if you are in the drawdown phase as downturns hit you harder.
So maybe playing some defense is worth losing out on missed upside?
 
I don't think the whole US market is in a bubble; rather a fairly small number of mostly tech stocks are driving up the high valuations. If you are well diversified outside the US and your investment timeframe is 8 years+, continuing to buy and hold is still the smart play.

A small tilt towards US value small cap stocks is worth considering. I've had my eye on something tracking the Russell 2000 index like XRS2 for a while but haven't pulled the trigger.
 
I am not weighing in on whether there is a bubble or not.

The only real way to avoid it is to shift your allocation to bonds. There is some upside in bonds given that interest rates are well above zero now.

I thought anyone holding bonds c. 2018-2021 was crackers as there was little potential for capital gain and a big potential for capital loss. But I wouldn't say that any more.
 
Steven Barrett said:
I don't think it is.

The dot com bubble saw Cisco with a peak PE ratio of 472. Nvidia, the fastest growing big company in the US has a PE ratio of 68.

These companies are also posting record profits at the moment.

Just keep buying.
Click to expand...
Microsoft had a price to earnings ratio of about 40 prior to dot com collapse, its peak share price was $110 or there abouts in 1999 , its share price fell all the way down to $15 during financial crash in 2010.
You had to wait 14 years for one of the best tech companies in the world to recover with huge capital loss (if you sold in those years) . So a huge amount of people lost out investing in Microsoft even if it subsequently recovered to the most valuable company in the world again
 
Aren’t treasuries the problem though? An extra couple of trillion borrowed dollars flowing into US equities via the economy every year, what happens when that tap gets turned down? Earnings soften/plummet.
 
Steven Barrett said:
I don't think it is.

The dot com bubble saw Cisco with a peak PE ratio of 472. Nvidia, the fastest growing big company in the US has a PE ratio of 68.

These companies are also posting record profits at the moment.

Just keep buying.
Click to expand...
Shiller CAPE just shy of 38 today. Sure it hit 44 prior to the dotcom bust, but let’s not kid ourselves that US equities are not in very bubbly territory, it is after all the second highest it’s ever been, ie crashes have happened from lower price/earnings multiples than todays!
 
I prefer to think of things in terms of probabilistic prospective returns......in that context US indices.......specifically their current operating earning multiples and then the underlying profit margins of its constituent companies are at historically elevated levels.....by some measures about as high as they've ever been

So probabilistically.....one would not choose these levels......if you we're seeking say the 9- 10% historical annual returns that US markets have enjoyed in the past to play out for the next decade....to do so, to get to that 10% annualized return.....would require somewhat implausible things to happen from right here, right now:

(1) that investors, paying already elevated multiples of earnings, would decide to pay even more.....such that you would get continued sustained earnings multiple expansion on top of earnings growth that would plateau at some level higher than where we are today or have sustainably been ever....I'm not saying this cant happen in the short run.....markets can trade anywhere at anytime before returning to rationality.....SPY/QQQ multiples can go higher in the short or even intermediate term.....but they've historically never persisted at these multiples for any great length of time....in periods where multples we're elevated the general stock price level has been sustained and grew in these instances by underlying profit growth (margin expansion etc.) such that multiples came down as the earnings expanded.......but today we get to no (2)

(2) that US profit margins (already historically elevated) would expand further from here.....we are in quite rarified air in terms of margins....that they would expand from here to support stock prices as say the underlying earnings multiple contracted to more average level also seems implausible.

Valuation is not a short term timing tool......rather its a probabilistic expected return tool... probabilistically.....expected 10yr returns are low for US indices.....when you overlay the fiscal situation in the US....running 6-7% budget deficits during a period of full employment....what you also realize is that the US government via borrowing & spending is stimulating US economic activity at an unprecedented level for peacetime....and in a very real sense this fiscal borrowing is flowing through to US corporates as elevated profit margins and profits...and to the public as excess liquidity from which they can speculate on the stock market in their 401k's and Robinhood accounts......whether this continues or not will have a large bearing on what happens next to earnings and folks enthusiasm to buy a claim on those earnings.

For an Ireland based investor......SPY & QQQ....present real challenges IMO...everything I've highlighted above.....to which you can add currency risk......given the current EUR/USD exchange rate....which again is at something of a historical high (albeit SPY/QQQ has some natural hedging given the international earnings profile).

I say all this for the indices......there are plenty of companies that have plausible and probable avenues to provide an investor with high single digit 10yr returns.....and assembling a basket of these would make more sense than relying on expanding enthusiasm for SPY/QQQ right now
 
the last time we had such high valuations of US stock markets and technology stocks was in year 2000/2001 when the dot com crash happened the US underperformed Europe and the rest of the world for basically the next decade until the financial crash, also the value of the US dollar fell all the way back to $1.5 to the euro. Nobody can predict the future but if the Ukraine war is resolved in the next year that will be a big positive for Europe.
European markets have not performed like the US for years however they have been performing much better since Covid than they were in the years from the financial crash to year 2021. So I think the fixation on the US markets is a mistake, I think covid was the turning point
 
I can’t really agree with this statement. My euro investment is lagging behind my US by 40% since the end of Covid19 (not that it has ended just changed).
 
Always be sceptical of saying things are "clearly" in a bubble. Yes I see signs of froth in certain submarkets but I'd be loathe not to have a majority of my listed assets being US equities given their proportion of the global economy and track record of performance.
 
In terms of valuations, a quick Google shows that US bond yields were 6% in 2000 (having dropped considerably over the previous decade) but are 4.2% now. Current inflation rates are also relatively low- even taking into account the last few years, the long term annualised rate is on target.

Valuation of anything by reference to an income/expenditure stream requires factoring in government bond yields (ie guaranteed returns) and inflation. If both are (and are expected to remain) low as compared to 2000, higher P/E ratios should be expected because a lower return % still offers a premium over the bonds.

On a wider note, there's no reason to think the US will suddenly turn around and end the domination of their stock indices by a relatively small number of megacorps. That would require regulations to prevent the development of oligopolies in the relevant industries and that doesn't seem to be the American way....

That said, the nasdaq 100 (which i pay more attention to) is overvalued by 15-20% based on long term average annualised returns. But that information is useless- I've no idea when it will correct to the average or over what time frame.

I also think hysteria over the dot com crash is wildly overblown. In 1995 the Nasdaq 100 was at 925, in 2005 it was at 2100. Equivalent S&P 500 figures are 540 and 1200. The crash was only a problem for people who bought the bubble and sold the bust- ie the people who tried to time the market and failed like virtually everyone else who tries that trick.

Yes there were individual stocks that evaporated, but the index was basically fine. The lesson (aside from not trying to time the market) is the same one we were taught in primary school- don't put all your eggs in one basket.
 
joe sod said:
European markets have not performed like the US for years
Click to expand...

With good reason….Europe is full of low growth, low RoE businesses that carry either high leverage ratios (financials) or have high capital requirements (industrials)…the US markets are full of the opposite….the US has rightly outperformed EU/UK peers….and should carry a higher multiple….however the the multiple premium has reached levels that now make little sense….raising the price of an asset all things being equal reduces its future return…US have been systematically bid up these last few years
 
joe sod said:
Nobody can predict the future but if the Ukraine war is resolved in the next year that will be a big positive for Europe.
Click to expand...

I'm not so sure about this - Russian cheap energy is not coming back in a timeframe that matters for Europe's industrial competitiveness....looks to me like Europe is now operating with energy prices that are now two to three times structurally higher than the US.

IMO European equity market outperformance will come more from a re-pricing downwards of US assets than some marked improvement in underlying European company performance.
 
SquirrelChaser said:
If both are (and are expected to remain) low as compared to 2000, higher P/E ratios should be expected because a lower return % still offers a premium over the bonds.
Click to expand...

Yes equities should always be priced to provide a premium over bonds........the issue today is the tightness of the spread......or the equity risk premium (ERP)....which accounts for those two variables you've outlined across decades....this spread sits at one of the lowest levels on record....which is to say equity investors are accepting one of the lowest premiums they ever have relative to risk free bonds available to them.

So much so the ECB calls it out its in its own financial stability report -

https://www.ecb.europa.eu/press/fin...ons/fsr/html/ecb.fsr202411~dd60fc02c3.en.html
"as indicated by record low equity risk premia and relatively compressed corporate bond spreads on both sides of the Atlantic"

If I were to steelman the other side.....one might argue that the stock market investors....are looking through current bond prices....to a future period when they return to much lower levels.....such that they are front running an expanding ERP by owning stocks now knowing that there is a bond rally to come. I'm not so convinced........i think the US has worked for so long....that its going through what has all the appearances of being a melt up.....as investor pull funds from across the globe in under-performing markets to pile into the asset class with the best 3,5,10yr record....SPY/QQQ....
 
Status
Not open for further replies.
Menu
Log in
Register