What You Can Learn from America’s Growing Equity Bubble

Burst your bubble

It’s tough to find bargains in the stock market. What makes it even harder is optimistic investors pushing up prices. Right now this is a pretty accurate description of US investors at large.

The US Federal Reserve confirmed that it will move ahead with their tightening policy, believing the US economy is improving and ready to grow.

After the Fed’s remarks, US investors bid up the Dow Jones and NASDAQ indices to new record highs. As reported by The Australian Financial Review:

Economists argue that investors [are] unperturbed by the prospect that the Fed could start the process of reducing the size of its balance sheet as soon as September because US central bank boss Janet Yellen has promised to move at an extremely slow and measured pace.

But this nonchalance could also be a symptom of the overly-bullish sentiment that has gripped global financial markets. As the highly regarded investor Howard Marks — he co-founded the US debt giant Oaktree Capital — wrote in his latest investor letter, “I’m convinced ‘they’ are at it again — engaging in willing risk-taking, funding risky deals and creating risky market conditions.”

High Aussie expectations

It’s not just US investors that are eager to jump on the stock market growth-bandwagon. Credit Suisse analyst Hasan Tevfik wrote in a note to clients:

A stronger global economic backdrop and a stabilising Aussie economy should be enough to support further earnings-per-share [EPS] from here.

Tevfik’s team has forecasted record positive EPS growth in all major sectors over the next 12 months. Credit Suisse believes ‘…the combination of rising earnings and higher bond yields is a positive one for value and cyclicality in Australia.’ According to The Australian Financial Review, Credit Suisse hasn’t been as bullish on earnings in 10 years.

Yet I would argue their optimism should fuel your pessimism. Imagine a majority of analysts are forecasting growth for the next year. Because many investors don’t want to miss out, they pile into the market, favouring ‘growth’ stocks.

However, as the price climbs higher, the same growth becomes less attractive. Yet the buying activity pushes stock prices higher and encourages more investors to jump in.

With the Australian earnings season around the corner, I suggest you not get caught up in the growth story the wider market has adopted. Buying into already-high-valuation stocks could lead to disappointing returns in the long run.

Regards,

Härje Ronngard,

Junior Analyst, Markets & Money

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Härje Ronngard

Härje Ronngard

Harje Ronngard is a Junior Analyst at Markets and Money.

With an academic background in finance and investments, Harje knows how simple, yet difficult investing can be. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation.  

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