Is the Stock Market extremely overvalued?
Updated: Feb 2, 2021
After months of incredible rallies, which pushed the US stock market to record high levels, analysts and investors are wondering whether the stock market is currently extremely overvalued, in deep contrast with the real economy which is still struggling to recover. In fact, the gap between Wall Street and the real economy is getting bigger every month, with the S&P 500 going from the year low 2183.4 USD in March to 3869.71 USD (+77.24% increase) in just 10 months. Meanwhile, the US real GDP decreased by 3.5% in 2020 (US Bureau of economic analysis) and the unemployment rate went from 3.5% in 2019 to 6.7%. Many investors are worried whether the stock market is in bubble territory, since American families have a record high exposure to the stock market, even more than the 1999-2000 period during the dotcom bubble, according to JP Morgan. American households have approximately 40% of their savings invested in the stock market, directly or through investment funds, which is much more than Europeans (25%) and the Japanese (10%). This phenomenon can be partially explained by the trillions of dollars that the Federal Reserve injected into the system, but shows the fragility of the stock market, since retail investors and families tend to be emotional and likely to sell their assets during a market crash, making it even worse. So, should we be worried?
Many factors indicate that we are experiencing a stock market bubble. The fracture between the stock market and the real economy could be partially justified by incredible amounts of liquidity, low-interest rates, and a high level of optimism about recovery during 2021. However, Pfizer’s CEO Albert Bourla recently said, at the virtual 2021 Davos World Economic Forum, that there is a “high likelihood” COVID-19 vaccines will become ineffective because of new variants of the disease, which would rise uncertainty among investors and possibly cause a market crash. In addition to that risk, we are witnessing hysterically speculative investor behavior, as we have seen on many stocks, the most famous one being GameStop. Some major tech companies, like Tesla, NIO, and many others which we have already talked about, are no exception as their stock value increased ten-fold in a few months without major changes in their revenues that could justify the price. Also, the Wall Street capitalization / M2 (monetary supply) ratio is really close to 2007 levels, just before the financial crisis. Warren Buffett, the legendary value investor and chairman of Berkshire Hathaway has been sitting on more than US$139 billion in cash since 2020 and has expressed his concerns about a possible market crash on multiple occasions. In fact, if we look at the Buffett Indicator, a ratio of the stock market’s total value over the nation’s economy (If the ratio is above 100%, it indicates overvaluation), the indicator is 218%, an all-time high. IPOs have also witnessed speculation, like Airbnb, which saw its stock price grow 100% on day one despite the difficult conditions for the business, Nongfu Spring up 80% from post-IPO price or Snowflake doubling on IPO, and so on…
On the other hand, according to JP Morgan, the average stock component of retirement and insurance funds is only 43.8%, compared to 47.6% in 2018, which means that not all categories of investors are involved. But we should not forget that in 2020 there has been a historic boom in online trading, with all online brokers like E-toro, Fidelity, Schwab, Robinhood, and Interactive Brokers reporting increased activity and massive signups. E-toro, for example, reported an average increase in new signups of 401% globally, between January and April, compared to 2019; while in Europe the transaction volume saw a 247% increase in the same period. Speculation on some of these platforms went extreme, Robinhood, for example, has been obliged to raise a billion dollars last week to re-integrate margins to assure leveraged trading volumes.
All things considered, it looks like the market is definitely overvalued in a period of uncertainty and economic contraction. We don’t know if covid-19 variants will slow the vaccination progress and economic recovery while central banks keep interest rates low and approve expansionary monetary policies, which allow the market to stay overvalued indefinitely. Nobody knows when the crash will take place, but some form of strong correction will likely come soon or later. Governments must keep stimulating the economy, but it is not clear to what extent record-high public debt will be considered acceptable in the long term