Why Analysts Remain Unconcerned about a Stock Market Bubble

• Over the past 18 weeks, the S&P 500 has experienced a 16-week climb and reached a new all-time high on Friday. However, the gains have been primarily focused on the "Magnificent 7" stocks.
• UBS strategists assert that there is no bubble imminent to burst, despite similarities with the market climate of the late 90s, prior to the dotcom bubble.
• TS Lombard believes that the current bull market lacks a vital element to be classified as a bubble.

Although the U.S. market's focus is on expensive, AI-centric tech stocks, analysts believe Wall Street is not yet in bubble territory.

In June, the U.S. Federal Reserve is predicted to reduce interest rates, which may positively impact high-growth tech stocks.

Some concern about a market bubble has been raised due to the massive size and limited scope of the bull run, as strategists made comparisons with the late 1990s on Wednesday.

In 1995, after the Fed raised interest rates to 6%, the S&P 500 experienced a bull run that resulted in an annualized return of over 27% over the next five-plus years.

Until the bubble burst spectacularly in March 2000.

UBS Chief Strategist Bhanu Baweja and his team stated in a research note that the 90s bull run had two phases: a broad, steady climb from early '95 to mid '98, and then a narrower, more explosive phase from late '98 to early '00.

"The market's second phase is reflected in today's sectoral patterns, narrowness, and correlations, as well as in valuations that are not far off."

Baweja contended that "there's no bubble waiting to burst," and highlighted significant disparities in earnings, realized margins, free cash flow, IPO and M&A activity, and indications from options markets.

The missing ingredient

According to a research note by TS Lombard, the top 10 companies in the S&P 500 account for approximately 34% of the index's total market capitalization.

The stellar earnings of these firms justify the concentration of research in this area.

According to Skylar Montgomery Koning, senior global macro strategist at TS Lombard, the Tech sector's participation is crucial for the overall index to rally significantly, and the index is also vulnerable to the risks specific to these companies.

The recent improvement in stock market breadth can be attributed to the Fed's dovish pivot and resilient economic growth, as evidenced by the all-time highs of European and Japanese indexes in recent weeks.

Montgomery Koning believes that the equity gains so far are justified by the policy and growth outlook, as well as a strong fourth-quarter earnings season.

Montgomery Koning stated that while the AI-driven bull run fulfills the first two criteria, it seems to lack the third ingredient necessary for a stock market bubble to inflate: liquidity, leverage, or both.

The speaker stated that while liquidity remains sufficient, leverage levels are not yet concerning. QT has not led to a decrease in liquidity in the US, as reverse repos absorbed reserves at a faster rate than the balance sheet. In fact, liquidity has slightly increased since the beginning of the year, with a risk that 2024 Fed cuts may exacerbate the situation.

"Although leverage does not appear concerning, the increase in margin debt and open interest indicates that speculation is not the primary driver of the rally. While there has been a slight increase in margin debt, it is nowhere near the peak levels of 2020."

The bad news?

UBS noted that the absence of a bubble does not guarantee that the market will continue to rise, and Baweja pointed out that productivity growth is not as strong as it was in the 1990s.

"Globalization has slowed down (actually weakened) compared to the late 1990s, when it grew the fastest. The economy is currently in a late cycle."

UBS predicts that the current state of the economy is similar to the end of the 90s bull run and early 2000, with weak real disposable income growth likely to worsen. Baweja believes that for the bull run to continue sustainably, the variables need to improve.