Sharing his "bubble gauge" about the current market trends, Bridgewater Associates founder Ray Dalio, in a LinkedIn post titled, 'Are We in a Stock Market Bubble?', determined that we are not.
Dalio harked back to his over 50 years of experience in investing and said he used this expertise to identify what makes a bubble and whether the current conditions qualify for market trends and stocks. According to him, the readings indicate that despite a significant equity rally, the market is unlikely to be in a bubble.
Dalio said he defines a “bubble” as one that has a combination of the following in high degrees:
– High prices relative to traditional measures of value (e.g., by taking the present value of their cash flows for the duration of the asset and comparing it with their interest rates).
– Unsustainable conditions (e.g., extrapolating past revenue and earnings growth rates late in the cycle when capacity limits mean that growth can’t be sustained).
– Many new and naïve buyers who are attracted because the market has gone up a lot, so it’s perceived as a hot market.
– Broad bullish sentiment.
– A high percentage of purchases are financed by debt.
– A lot of forward and speculative purchases are made to bet on price gains (e.g., inventories that are more than needed, contracted forward purchases, etc.).
The billionaire investor said he applied his criteria to the United States market and said even the parts that have rallied “don’t look very bubbly” and are not consistent with past bubbles.
On the Magnificent Seven — Alphabet (Google), Amazon, Apple, Meta Platforms (Facebook), Microsoft, Nvidia and Tesla, Dalio believed that these stocks are “a bit frothy but not in a full-on bubble” when looked at as aggregate.
In his analysis, Dalio felt Alphabet and Meta are “somewhat cheap” while considering Tesla as “somewhat expensive,” but called the group, in aggregate, as “fairly priced”. He added that the market cap of the basket has generally grown in line with earnings.
“The market cap of the basket has increased by over 80 per cent since January 2023, and these companies now constitute over 25 per cent of the S&P 500 market cap. The Mag-7 is measured to be a bit frothy but not in a full-on bubble. Valuations are slightly expensive given current and projected earnings, sentiment is bullish but doesn’t look excessively so, and we do not see excessive leverage or a flood of new and naïve buyers. That said, one could still imagine a significant correction in these names if generative AI does not live up to the priced-in impact,” Dalio said.
However, Dalio expressed lower confidence in these companies due to uncertainties surrounding the impact of artificial intelligence. “... we don’t have a high-confidence read on how impactful generative AI will turn out to be, and that is a significant influence on the expected cash flows of many of these companies,” he added.
We are assuming that analysts are making reasonable predictions for growth driven by generative AI. This is an area where we have lower confidence because there is so much inherent uncertainty and because it is not our area of expertise.
On bullish sentiment in the market, Dalio remarked that more people have already invested, so they are likely to have fewer resources to keep investing and are more likely to sell. “Sentiment in the market is now neutral to slightly positive—not in bubble territory,” he said.
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