Record-high stock prices are increasing the risk of ‘fragility shocks’ in the next few months, Bank of America says

Trader on the floor of the New York Stock Exchange
Bank of America said US stocks could be vulnerable to volatility.

  • Record-high stock prices and calm markets are increasing the risk of fragility shocks, Bank of America said.
  • The bank’s analysts said they think investors are underpricing the risk of a change in Federal Reserve policy.
  • However, the BofA analysts acknowledged that there is a strong “buy the dip” impulse among investors.
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Record-high stock prices and a possible change in Federal Reserve policy have heightened the risk of “fragility shocks” hitting equities in the coming months, Bank of America analysts said.

Last week’s sell-off on Tuesday and Wednesday was a sign that investor sentiment remains nervy and could be vulnerable to bigger shocks in the future, analysts including Riddhi Prasad and Benjamin Bowler said in a note on Tuesday.

Stocks have since rebounded to all-time highs, but the analysts said this “will merely encourage more of the investor behavior that historically precedes larger fragility shocks.”

In a note last week, BofA analysts said investors had been drawn into low conviction, momentum-driven positions that could be unwound all at once into an illiquid market if the tide turns.

Read more: Stocks faltered in a worrying way this week. 3 of Wall Street’s most renowned strategists unpack why they think things are about to get even uglier.

The bank’s analysts said in their latest note they’re particularly concerned about the potential risks surrounding a possible change in Federal Reserve policy, as the central bank debates when to start withdrawing support for the economy.

“We believe the US equity market is underpricing the risks of a looming tapering cycle. After all, the equity market has feasted on record monetary support post-COVID, and the Fed’s outlook remains impaired by the extreme uncertainty in the macro forecasts on which they base their decisions.”

The analysts did not spell out their exact definition of a fragility shock, but implied that it meant a relatively sharp drop in stock prices.

However, BofA acknowledged that last week’s market sell-off had been met by investors rushing to “buy the dip” in stocks, pushing them back higher. The analysts said that “the jury is out on whether these mini-selloffs are just a feature of today’s market or foreshocks preceding a larger fragility event.”

The S&P 500, the benchmark US stock index, has risen more than 90% since hitting a pandemic low in March 2020. It has consistently hit record highs over the last few months.

In the note last week, BofA said Federal Reserve Chair Jerome Powell’s speech at the virtual Jackson Hole meeting of central bankers on Friday could trigger stock market volatility. It also highlighted August US payrolls data, due on September 3, and the September 22 Fed meeting as potential catalysts.

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A rise in long-term interest rates will be ‘kryptonite’ for a stock market that is already ‘in the biggest bubble of my career’ investment chief Richard Bernstein says

Richard Bernstein

Investment chief Richard Bernstein thinks if long term interest rates rise further, this could burst the bubble he sees in stock markets today – which could be the biggest one of his career, he said.

In an interview on CNBC’s Trading Nation, Bernstein said he believes investors have bought into long duration assets because of low long-term interest rates thanks to Federal Reserve policy, leading to a bubble in the stock market. Long-duration assets could include the far end of the Treasury yield curve, bitcoin, tech or even meme stocks, he said.

“The Fed has so distorted the long-end of the curve that we are seeing a very natural reaction among long-duration assets which is then taking on a life of its own. And I think anybody who’s out there in these long-duration assets has to be firmly convinced that long-term interest rates are not going to go up, because that’s the kryptonite for this bubble,” Bernstein said.

“I personally think we are right in maybe the biggest bubble of my career,” he added.

Stocks have been rising for well over a year and hit record high after record high, as the US economy has recovered from the fallout of the COVID-19 pandemic. This has led to widespread talks of a bubble and many investment experts have been urging caution about the potential for a crash.

Billionaire Jeremy Grantham’s investment firm GMO called the current environment a global growth bubble last month, while ‘Rich Dad Poor Dad’ author Robert Kiyosaki told investors to prepare for a market crash and even retail traders agree, with 40% of them saying there is a bubble – but they do not believe markets will actually crash.

Bernstein urged retail investors to diversify away from those highly frothy assets, while the market is still in a bubble and investing seems simple.

“For the same reason we carry a spare tyre in our trunk, for the same reason we have a fire extinguisher in our homes, that’s the reason why you have to diversify and when you get into a bubble, diversification becomes more important because we know the bubble is going to burst, but we don’t know when,” Bernstein said.

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8 reasons why fears of a stock-market bubble are overblown, according to Goldman Sachs

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Goldman Sachs said that fears of a bubble were overblown.

  • Goldman Sachs said that fears of a bubble in markets were overblown, despite a few concerning signs.
  • The analysts gave eight reasons, including lower levels of leverage and risk-taking.
  • They also said the boom in tech stocks had a firmer basis than in the dot-com bubble of the 1990s.
  • Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

With retail traders driving up stocks like GameStop, blank-check companies booming, and bitcoin soaring, many investors are worried about bubbles in financial markets.

But Goldman Sachs analysts said in a note on Monday that fears about bubbles were overblown. There are a few worrying signs, but markets now appear much safer than they were during the dot-com crash or the 2008 financial crisis, they said.

Here are the eight key reasons investors should not be overly concerned about the recent market frothiness, according to Goldman analysts including Peter Oppenheimer and Sharon Bell.

1. The stock-market rally is driven more by fundamental factors.

In bubbles such as the dot-com boom of the late 1990s, investors drove up asset prices with little rational basis, and the fear of missing out triggered buying frenzies.

The rise in stock prices over the past few years, particularly in tech, “has been impressive” but “is not nearly as extreme as the explosive rise that accrued during the late 1990s,” Goldman said.

The rally in tech firms can mostly be justified by “superior growth and fundamentals,” the note said, with earnings far outstripping the rest of the market.

2. The “equity risk premium” measure does not look worrying.

Goldman said that much of the market frothiness could be explained by record-low interest rates around the world.

The bank’s analysts pointed to a key measure of stock value, the equity risk premium, or the extra return investors get on stocks compared with holding risk-free bonds.

Goldman said that in the bubble of the late 1990s, investors were so confident about growth that they were prepared to buy stocks offering a dividend yield of 1% when they could make 6.5% holding bonds.

But record-low interest rates and better prospects today mean the equity risk premium is higher, suggesting investors are much more justified in bidding up stocks.

Read more: Cowen says buy these 10 retail stocks before a colossal wave of consumer spending sends them skyrocketing – including one expected to surge 71%

3. Market concentration has increased – but is not dangerous.

Goldman said Facebook, Apple, Amazon, Microsoft, and Google were increasingly dominant, with a market capitalization nearly three times the annual GDP of India.

But the bank’s analysts said that such a concentration “has reflected strong fundamental growth, rather than the hope, or promise, of returns far into the future.” This suggests it’s far more sustainable than in previous asset rallies.

4. A big jump in retail trading has followed years of outflows from equities.

The GameStop saga in January brought the power of retail investors to the attention of Wall Street.

Goldman said that the rise in amateur investing had been “breathtaking” and that one of its key measures of risk-taking had hit a level associated with a 10% drop in stock markets.

But the analysts said that “while flows have been significant of late, we have come from many years of outflows from risk assets like equities.”

5. Credit is cheap, but investors aren’t being overly risky.

Central-bank interest rates are at record lows, as were bond yields until recently, making borrowing very cheap.

But Goldman said that speculative bubbles are associated with banks and companies funding risky activities through debt and with a collapse in household savings, which “is not the case today.”

Banks are very strong thanks to reforms, the note said, adding that US households had accumulated about $1.5 trillion in savings during the COVID-19 pandemic.

6. Mergers and acquisitions are booming from a low base.

The excitement about special-purpose acquisition companies, or SPACs, has many investors worried about frothy markets.

“Booming M&A activity and equity issuance are reminiscent of activity rates in previous cycles,” Goldman said.

But it added that the activity did not appear excessive “when adjusted for the market capitalization of equity markets.”

7. The surge in certain sectors is driven by profitable companies.

Market bubbles are often driven by an enthusiasm for new technologies, such as the internet in the dot-com era.

Goldman said that while tech and green stocks had indeed boomed, a fall in these stocks should not lead to widespread company collapses, as most of them are profitable.

8. Stocks are rising as economies recover from a slump.

The Wall Street bank said the powerful rally in stocks from last March to September was typical of a “hope” phase of a bull-market run after an economic slump.

“This phase is generally followed by what we call the ‘growth’ phase,” when earnings pick up, it said, though there could be bumps along the way.

Read more: Hedge funds are ramping up bets against Chamath Palihapitiya’s SPACs and have already taken home $40 million this year. Here’s a detailed look at the wagers they’re making.

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Goldman Sachs says fears of a stock-market bubble are overblown for these 8 reasons

GettyImages 1158933047
Goldman said fears of a bubble are overblown

  • Goldman Sachs said fears of a bubble in markets are overblown, despite a few concerning signs.
  • The Wall Street giant’s analysts gave 8 reasons why, including lower levels of leverage and risk-taking.
  • They also said the boom in tech stocks has a firmer basis than the dotcom bubble of the 1990s.
  • Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

With retail traders driving up stocks like GameStop, blank-check companies booming, and bitcoin soaring, many investors are worried about bubbles in financial markets.

But Goldman Sachs analysts said in a note on Monday fears about bubbles are overblown. There are a few worrying signs, but markets now appear much safer than during the dotcom crash, or 2008 financial crisis, they said.

Here are the 8 key reasons investors should not be overly concerned about the recent market frothiness, according to Goldman analysts including Peter Oppenheimer and Sharon Bell.

1. The stock-market rally is driven more by fundamental factors than investor craziness

Past bubbles such as the dotcom boom of the late 1990s saw investors drive up asset prices with little rational basis, with buying frenzies triggered by the fear of missing out.

Goldman said the rise in stock prices over the last few years, particularly in tech, “has been impressive… but it is not nearly as extreme as the explosive rise that accrued during the late 1990s.”

The rally in tech firms can mostly be justified by “superior growth and fundamentals,” the note said, with earnings far outstripping the rest of the market.

2. The key ‘equity risk premium’ measure does not look worrying

Goldman said much of the market frothiness is explained by record-low interest rates around the world.

The bank’s analysts pointed to a key measure of stock value, the equity-risk premium. This is the extra return investors get on stocks compared to holding risk-free bonds.

Goldman said in the bubble of the late 1990s, investors were so confident about growth they were prepared to buy stocks offering a dividend yield of 1% when they could make 6.5% holding bonds.

But record-low interest rates and better prospects today mean the equity-risk premium is higher, suggesting investors are much more justified in bidding up stocks.

3. Market concentration has increased – but is not dangerous

Goldman said Facebook, Apple, Amazon, Microsoft and Google are increasingly dominant, with a market capitalization nearly 3 times the annual GDP of India.

But the bank’s analysts said such a concentration “has reflected strong fundamental growth, rather than the hope, or promise, of returns far into the future.” This suggests it is far more sustainable than in previous asset rallies.

4. A big jump in retail trading has followed years of outflows from equities

The GameStop saga in January brought the power of retail investors to the attention of Wall Street.

Goldman said the rise in amateur investing has indeed “been breathtaking.” And it said one of its key measures of risk-taking has hit a level associated with a 10% drop in stock markets.

Yet the analysts said: “While flows have been significant of late, we have come from many years of outflows from risk assets like equities.”

5. Credit is cheap, but investors aren’t being overly risky

Central bank interest rates are at record lows, as were bond yields until recently, making borrowing very cheap.

But Goldman said speculative bubbles are associated with banks and companies funding risky activities through debt, and a collapse in household savings, which “is not the case today.”

Banks are very strong thanks to post-crisis reforms, the note said. US households have accumulated around $1.5 trillion in savings during COVID-19, the bank said.

6. Mergers and acquisitions are booming from a low base

The mania for special-purpose acquisition companies, or SPACs, has many investors worried about frothy markets.

Goldman said: “Booming M&A activity and equity issuance are reminiscent of activity rates in previous cycles.”

But it added activity does not appear excessive “when adjusted for the market capitalization of equity markets.”

7. The surge in certain sectors is driven by profitable companies

Market bubbles are often driven by a craze for new technologies, such as the internet in the dotcom era.

Goldman said tech and green stocks have indeed boomed. But the analysts said a fall in these stocks should not lead to widespread company collapses, as most of them are profitable.

8. Stocks are rising as economies recover from a slump

The Wall Street bank said the powerful rally in stocks from March to September last year was typical of a “hope” phase of a bull-market run after an economic slump.

“This phase is generally followed by what we call the ‘growth’ phase,” they said, when earnings pick up, although there could be bumps along the way.

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The stock market is not in a bubble for these 2 reasons, DataTrek says

Stock Market Bubble
A trader blows bubble gum during the opening bell at the New York Stock Exchange (NYSE) on August 1, 2019, in New York City.

  • The stock market is not yet in a bubble, DataTrek co-founder Nicholas Colas said in a note on Wednesday.
  • Two conditions that define stock market bubbles are fast rising valuations and retail investor fervor, according to the note.
  • “We don’t have the first, and the second is just starting,” Colas said.
  • Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

The stock market is not yet in a bubble, but a “baby bubble” might be forming, DataTrek co-founder Nicholas Colas said in a note on Wednesday.

In order for a bubble to even form in the stock market, two conditions are necessary: fast rising valuations and retail investor fervor, according to the note.

“We don’t have the first, and the second is just starting,” Colas said.

Based on the Shiller PE ratio, the bubbles of 1929 and 2000 were evident when a sharp move higher in valuations occurred. It’s about the rate of change in valuations, not the absolute valuation levels that indicate a bubble is present, according to the note.

So far, the current reading of the Shiller PE ratio does not indicate that a bubble is forming in stocks, the note said.

Read more: Tesla just invested $1.5 billion in bitcoin. Here are the bull and bear cases for the crypto, according to legendary macro trader Mike Novogratz and Goldman’s wealth management CIO.

shiller.JPG

“To our eyes the current-day red dot above lacks the antecedent spike of either 1929 or 2000, so by this measure we can’t call the current US equity market in a bubble,” Colas said.

While the stock market is not in a bubble yet, it is possible that one could be forming, according to DataTrek.

Heightened Google search trends for terms like “buy stocks,” “stock bubble”, and “stock market bubble”, have increased recently. The search trend data represents preconditions to create a stock market bubble “in terms of social attention on equities,” Colas said.

Retail investors have piled into the stock market since the COVID-19 pandemic, with $0 commission trading apps like Robinhood making it easier than ever to begin buying and selling stocks. The heightened retail activity was apparent last month after a Reddit forum helped spark a gravity-defying short-squeeze in shares of GameStop.

But while more retail investors are participating in the stock market, that doesn’t mean it’s time to sell stocks, the note said.

“We have not yet had the sort of valuation run up that says it’s time to sell,” Colas said, adding that investors should remain invested in US large cap and emerging market stocks. 

And while trying to call the top of a bubble remains appealing for investment professionals, it’s ill-advised.

“Even if you’re more bearish than us, remember that the end of the world only happens once so timing is everything for that trade. And early is the same as wrong,” Colas concluded. 

Read more: Credit Suisse says to buy these 16 ‘highest-conviction’ stock picks that are set to outperform despite the market’s contrarian view

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Legendary investor Jeremy Grantham says Biden’s $1.9 trillion stimulus plan will make the stock market bubble even worse

Jeremy Grantham

Legendary investor Jeremy Grantham warned investors during a Bloomberg interview that the $1.9 trillion in federal aid President Joe Biden is seeking from Congress will further inflate the stock market bubble.

The GMO co-founder told Erik Schatzker that he has “no doubt” some of the stimulus aid will end up in the market. He said the “sad truth” about the last stimulus bill passed in 2020 was that it didn’t increase capital spending and didn’t increase real production, but it certainly flowed into stocks. 

The plan that Biden is proposing contains a $1,400 boost to stimulus checks, robust state and local aid, and vaccine-distribution funds. Grantham said that if the package passed is worth $1.9 trillion, it could lead to the dangerous end of the bubble.  

“If it’s as big as they talk about, this would be a very good making of a top for the market, just of the kind that the history books would enjoy,” said Grantham.

“We will have a few weeks of extra money and a few weeks of putting your last, desperate chips into the game, and then an even more spectacular bust,” he added. 

Read more: A notorious market bear who called the dot-com bubble says he sees ‘fresh deterioration’ in the market indicator that first signaled the 1929 and 1987 crashes – and warns that stocks are ripe for a 70% drop

Grantham has long-warned of the ballooning bubble he sees in the US stock market. In his investor outlook letter in the beginning of January, he detailed how extreme overvaluations, explosive price increases, frenzied issuance, and “hysterically speculative investor behavior” all demonstrate that the stock market is in a bubble that not even the Fed can stop from bursting.

“When you have reached this level of obvious super-enthusiasm, the bubble has always, without exception, broken in the next few months, not a few years,” Grantham told Bloomberg.

Grantham also said that the combination of fiscal stimulus and emergency Fed programs that helped inflate the bubble could increase inflation.

“If you think you live in a world where output doesn’t matter and you can just create paper, sooner or later you’re going to do the impossible, and that is bring back inflation,” Grantham said. “Interest rates are paper. Credit is paper. Real life is factories and workers and output, and we are not looking at increased output.”

He told investors to seek out stocks outside of US markets, as many other countries haven’t seen the huge bull market the US has. He called emerging markets stocks “handsomely priced.”

“You will not make a handsome 10- or 20-year return from U.S. growth stocks,” said Grantham. “If you could do emerging, low-growth and green, you might get the jackpot.”

Read more: GOLDMAN SACHS: These 22 stocks still haven’t recovered to pre-pandemic levels – and are set to explode amid higher earnings in 2021 as the economy recovers

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Stocks are in a ‘rational bubble’ as long as investors remain confident in continued Fed support, economist Mohamed El-Erian says

Mohamed El-Erian
  • Mohamed El-Erian told CNBC stocks are in a “rational bubble” and asset prices will continue to rise as long as the Federal Reserve signals to investors that it will continue to support the markets. 
  • “It’s rational because the Fed and the ECB keep on signaling that they will continue to inject massive liquidity, and as long as the market is confident that that’s the case, it will drive prices higher,” the Allianz chief economic adviser said. 
  • El-Erian said that the US will continue to see a contrast between what the market is doing and what the broader economy is indicating because of the liquidity in the market.
  • Visit Business Insider’s homepage for more stories.

Mohamed El-Erian told CNBC on Wednesday stocks are in a “rational bubble” at the moment and asset prices will continue to rise as long as the Federal Reserve signals to investors that it will continue to provide support for the markets.

“This is not an irrational bubble. This is a rational bubble,” the Allianz chief economic adviser said. “It’s rational because the Fed and the ECB keep on signaling that they will continue to inject massive liquidity, and as long as the market is confident that that’s the case, it will drive prices higher.”

Typically, a stock market bubble is created when asset prices surge to levels that greatly exceed the their intrinsic value. Legendary investor Jeremy Grantham said on Tuesday that the stock market is in a  “fully-fledged epic bubble,” driven by extreme overvaluations, explosive price increases, frenzied issuance, and “hysterically speculative investor behavior.” 

For El-Erian, there is a rational reason why stock prices keep going up, and it’s investor confidence in support from the Federal Reserve.

Read more:Deutsche Bank says buy these 14 beaten-down financial stocks poised for a bullish recovery from 2020’s ‘savage sell-off’ – including one that could rally 30%

Stock prices ballooned in 2020: the S&P 500 gaining 16%, while the tech-heavy Nasdaq soared 43%. El-Erian said there’s so much liquidity “sloshing around the system,” that stock prices will continue to move higher this year.

The result is that stock prices continue to rise despite political and economic turmoil outside of Wall Street.  On Wednesday as protesters stormed the US Capitol building, the stock market remained unbothered. The Dow Jones closed at a record high, while the S&P 500 closed up 0.5%. 

El-Erian said that the US will continue to see a contrast between what the market is doing and what “conditions on the ground” are saying because of the liquidity in the market.

Also on Wednesday, the ADP monthly employment report revealed that the US lost 123,000 private payrolls in December. The reading marks the first contraction in nationwide hiring since April. El-Erian said that the report was a “big miss” and demonstrates the “power of liquidity.” 

 

 

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