Better strap in and be prepared to ride the second wave of “irrational exuberance” fellow Fools!
That’s the term used by former US Federal Reserve Alan Greenspan to describe the tech bubble at the turn of the century.
We know how dramatically that bull market ended with overstretched valuation proving to be too much for share markets to withstand.
The same questions are being asked now with the S&P/ASX 200 Index (Index:^AXJO) rebounding close to 30% in just two months from its COVID-19 lows.
Tech bubble 2.0?
US equities have jumped even harder and that’s largely due to the tech titans Facebook, Inc. (NASDAQ: FB), Amazon.com, Inc. (NASDAQ: AMZN), Apple Inc. (NASDAQ: AAPL), Netflix Inc (NASDAQ: NFLX) and Alphabet Inc (NASDAQ: GOOG).
You can see the connection with irrational exuberance, especially when experts warn the US market is expensive no matter now you look at it.
Oxford Economics is one ringing the warning bell as it believes US shares may be as much as 16% overvalued, according to Bloomberg.
Shares overpriced on multi-levels
The strategist for the forecasting and quantitative analysis firm, Daniel Grosvenor, even suggested that shorting the market is looking increasingly favourable.
“The S&P 500 is expensive versus history on almost all the measures we consider,” Grosvenor said.
Bloomberg reported that his measure of valuing companies by discounting the value of their future cashflows would still be 6% overvalued even with an assumption of a much higher terminal growth rate of 4%. The terminal growth rate assumption is usually set at CPI or a little less.
Is the ASX in a bubble?
Our market is also looking stretched. The ASX 200 is trading on a price-earnings multiple of around 17 times, or over 13% above its long-term average.
Given that the earnings growth outlook is pretty weak as the global economy gradually recovers from the coronavirus shutdown, some would argue the market should be priced at a discount to its average – let alone a premium.
These lofty valuations leave equities prone to a sharp sell-off when we hit the next storm cloud. I’ve listed a number of near-term thorny issues that could pop the bull party balloon here.
It’s not valuation, stooped!
But I don’t believe this isn’t the time to cut and run even as the valuation warning light flashes. This call isn’t based on irrational optimism either!
Remember the words from famed economists John Maynard Keynes? The market can stay irrational longer than you can stay solvent.
The tech wreck proved this. Greenspan’s warning of irrationality came in 1996 but the party didn’t stop till 2001. There have been a number of highly regarded fund managers who tried shorting the NASDAQ before the crash and they run out of money before they could collect on their bet.
Foolish takeaway
The thing is, valuations in themselves seldom spell the end of a bull run. We were struggling with this issue even before COVID-19, and if the pandemic didn’t happen, I believe the markets would have kept pushing to new record highs.
Irrational or otherwise, this bull run feels to me like it still has legs in the short-term and that’s in no small part due to the record amount of stimulus injected into the global financial system.
This doesn’t mean we won’t see a big correction, but unless something else pops out from left field, signs are pointing to more gains for the ASX over the coming weeks, if not a bit longer.
As the market adage goes – the trend is your friend.
Just don’t be the one holding the parcel when the music stops.
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But you will have to hurry — history has shown the market could bounce significantly higher before the virus is contained, meaning the cheap prices on offer today might not last for long.
More reading
- These were the best performing ASX 200 shares in May
- 3 five-star ASX 200 shares to buy in June
- What to watch on the ASX 200 next week
- How to be an ASX 200 share millionaire in 15 years
- Where to invest $20,000 in ASX 200 shares today
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool’s board of directors.
Brendon Lau has no position in any of the stocks mentioned. Connect with me on Twitter @brenlau.
The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of and recommends Amazon, Apple, Facebook, Microsoft, and Netflix and recommends the following options: long January 2021 $85 calls on Microsoft, short January 2021 $115 calls on Microsoft, short January 2022 $1940 calls on Amazon, and long January 2022 $1920 calls on Amazon. The Motley Fool Australia has recommended Amazon, Apple, Facebook, and Netflix. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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