Is the US stock market in a bubble?

The author is co-founder and chairman of Oaktree Capital Management and author of “Mastering the Market Cycle: Get the Odds on Your Side”

These days many investors are wary of stock price booms, worried about a repeat of the past.

Therefore, I am often asked if there is a bubble around the stocks that have been leading the S&P 500 stock index, the so-called “Magnificent Seven” technology companies that have dominated the index in recent years like this and are responsible for great growth. an unlimited share of its benefits.

You can look at quality parameters to detect bubbles but I have always believed that psychoanalysis is more effective. I look for irrational exuberance – the clear respect for a group of companies or assets that creates a great fear of being left behind if one fails to participate in the bubble with the conviction that, for these stocks, “when it’s too expensive”. In particular, when I hear the latter, I take it as a sure sign that the bubble is bursting. In short, bubbles are characterized by bubble thinking.

If bubble thinking is irrational, what allows investors to escape rational thinking? There is a simple answer: youth. This event is based on another saying of time investment, “this time is different”. Bubbles have always been associated with new developments, from the 1630s in Holland with the newly introduced tulips, to the internet and mobile phones in the late 1990s. . Since there is no historical indication of what the new thing’s true value is, there is nothing to tie it to terra firma.

The bubbles I’ve lived in have had developments, many of which were either guessed or not fully understood. The benefits of a new product or business method are often obvious, but the pitfalls and pitfalls are often hidden. A new company may completely surpass its predecessors, but investors often fail to understand that even a bright young person can be replaced. Disruptions can be disrupted, either by competitors with knowledge or new technology.

In the 1990s, investors were convinced that “the internet will change the world”. It certainly looked like that, and that thought created a huge demand for everything related to the internet. The e-commerce stocks were announced at seemingly high prices and tripled in the first day. There is often a grain of truth underlying every mania and bubble. It’s just taken too far. The Internet completely changed the world, but most of the dotcom companies that boomed in the late 1990s ended up going bankrupt.

Being too optimistic about something new leads to pricing mistakes. Because bubble participants don’t think there are problems, they often give rewards that take success. In fact, only a few newcomers can succeed, or even survive.

Stocks are traded at multiples of next year’s earnings, reflecting the expectation that they will continue to make money for many years. When you buy stock, you buy a share of the company’s earnings each year into the future. When you buy a stock at a price above the average multiple earnings, investors are paying for the companies’ profits – even after giving them credit for significant growth – for decades into the future.

Today’s top S&P 500 companies are, in many ways, better than the top companies of the past. They enjoy great technological advantages and great scale. But persistence is not easily achieved, especially in high-tech sectors that are vulnerable to disruption. In bubbles, investors treat leading companies as if they are certain to maintain their leadership for decades. Some do, some don’t, but the change seems more formal than persistent.

Is the US market too high? It is very rare for the S&P 500 to return 20 percent or more for two consecutive years. It happened In the past two years, the S&P 500 has risen 24.2 percent in 2023 and 23.3 percent in 2024, which brings us to 2025. What lies ahead?

Warning signs today include the optimism that has prevailed in the market since the end of 2022, the enthusiasm being spent on the new phenomenon of AI, and the widespread opinion that the top seven companies will continue to prosper. On the other hand, the p/e ratio on the S&P 500 is high but not crazy at 23.6 times. I also don’t hear people say, “no price is too high” and the markets, even if they are expensive or maybe murky, don’t look good to me.