Recent discussions within the investment community have been centered around the topic of whether or not we are currently in a bubble in equities, particularly in AI-related stocks. At Man Group, there is no official house view on the matter, as the company values the ability of their portfolio managers to operate with freedom. Instead, they aim to consider various viewpoints within the firm and communicate them to clients effectively. While there are some signs of bubble-like characteristics forming, determining the existence of a bubble is not enough to time investment decisions accurately.
Henry Neville, a portfolio manager in Man Group’s multi-asset business, has provided insights into market history and indicators that can predict long-term forward returns for equities. These indicators include the Cyclically-Adjusted P/E ratio identified by Robert Shiller, Tobin’s Q, and Household Stock Ownership as a proportion of financial assets. When comparing these indicators to the inverted 10-year realized CAGR of the S&P 500, the outlook for nominal 10-year forward returns appears to be between -4% to +3%, which is lower than the 12% average return over the past decade.
Analyzing historical bubbles, Henry Neville presented a comparison of the account curves of major bubbles throughout history. This comparison showed significant variations in duration and shape, with some bubbles following a classic inverted triangle pattern while others demonstrating more nuanced paths. By aggregating all the historical bubbles into one line, a typical bubble anatomy could be outlined, consisting of four stages: a 40% rise in price, a 10% euphoria zone, a 30% plateau, and a 20% crash. Understanding these stages can provide insights into where the current market may be in terms of a potential bubble, as well as the timing of any corrective movements.
When considering the timing of a bubble burst, it becomes apparent that attempting to exit the market too early can lead to missed opportunities for further upside. Looking back at past bubbles, such as the DotCom bubble, it is evident that relying solely on indicators like valuation metrics may not provide accurate signals for market exits. Instead, it is essential to understand the stages of a typical bubble cycle and assess where the current market stands in relation to these stages. This can help investors make more informed decisions about when to adjust their investment strategies in response to potential bubble dynamics.
Overall, while there may be signs of bubble-like characteristics forming in equities, particularly in AI-related stocks, a cautious approach to market timing is necessary. Understanding historical precedents and indicators can provide valuable insights into potential future market movements. By recognizing the stages of a typical bubble cycle and assessing where the current market stands in relation to these stages, investors can make more informed decisions about their investment strategies and potential risks associated with market bubbles.
