The stock is in bubble territory, Richard Bernstein said in a recent note.
He said cryptocurrencies are also in a bubble.
He shared how best to invest in the stock market during a bubble period.
It’s a question that arises when asset prices soar to astronomical levels as they have this year: are we in a bubble?
For Richard Bernstein — a 39 year old market veteran who has placed Institutional Investor in its “Hall of Fame” – the answer is yes, at least for large swaths of the stock market and for the crypto space.
The S&P 500 hit all-time highs Friday, breaking above 4,600 for the first time. Technology and disruptive stocks are the most inflated, Bernstein said in a recent note. Alphabet, Microsoft, Apple, Amazon, Tesla and Meta Platforms (formerly Facebook) make up about 25% of the S&P 500.
Crypto prices have also largely skyrocketed. Bitcoin has risen by more than 42% since September 30. Ethereum has risen nearly 48% in that time. Coin the joke Shiba Inu increased by 957% over the same period.
But why is Bernstein, a former chief strategist at Merril Lynch who now heads Richard Bernstein Advisors, so confident that stocks and crypto are in a bubble? Earlier this year, he explained his bubble criteria, shown in the flowchart below.
Richard Bernstein Advisors
These criteria have been met, he reiterated in a recent note after first saying so in June.
Since the start of the pandemic, the Federal Reserve has flooded the market with massive monetary stimulus, bought assets and lowered interest rates. Congress has passed unprecedented amounts of fiscal stimulus. About a third of the money in circulation in the US today has been printed in the past 18 months.
Federal Reserve Bank of St. Louis
There has been plenty of stock speculation over the past year, with retailers piling up on meme stocks like AMC and GameStop. The same has happened in crypto with dogecoin and now shiba inu.
The yield curve, which shows yields for government bonds with different maturities, is flattening. This means that the gap between the yields on shorter-dated bonds and their longer-dated counterparts is narrowing. This generally indicates a longer-term bearish investor outlook. A yield curve inversion – when the yield on shorter-term bonds is higher than the yield on longer maturities – is a reliable
recession indicator.
The chart below shows prices moving towards an inversion. Recessions have occurred shortly after the last seven inversions.
Gurufocus
Finally, a number of industries are experiencing shortages, leading to real asset inflation. The consumer price index, a primary measure of inflation, has now risen above economists’ expectations for about 6 consecutive months. On an annual basis, the CPI has increased by 5.4%.
How to invest in a bubble?
Investor speculation has increased in these economic conditions. And Bernstein warns that things will not end well for most investors if the bubble bursts.
That’s because bubbles are hard to time. So Bernstein doesn’t recommend trying this. Instead, he said investors should shift assets to underallocated areas of the market. During the dot-come bubble, these were areas such as financials, small caps and healthcare.
These investments still outperformed technology stocks and the S&P 500, even if left well before the 2000 bubble burst.
“If you had sold Tech and bought the other side of the market (ie small cap value, financials, energy), you could have been three years early and still have had superior returns,” he said.
The chart below shows two-year returns for various market segments after March 2000.
Richard Bernstein Advisors
Bernstein’s views in context
Bernstein is far from the only one to call the stock market overvalued. About half of key strategists at major Wall Street banks believe the S&P 500 will end the year lower than its current level of 4,605. The 2021 median target for the index among them is 4,600.
To cite a few examples: Savita Subramanian of the Bank of America recently warned that the S&P delivers 0% annualized return in the next decade. Stifel’s Barry Bannister said in recent days that stocks will correct 10% before the end of the year. Morgan Stanley’s Mike Wilson has also warned of a potential 20% sell-off.
But some remain bullish. Wells Fargo and Goldman Sachs have year-end price targets for the S&P 500 at 4,825 and 4,700, respectively.
However, many questions remain. Consumer spending has remained strong and can continue to support earnings. But other indicators, such as job growth, have declined. How investors react when the Fed phases out asset purchases is another unknown. So how high inflation could rise, and if, how and when the Fed would take steps to crush it.
Crypto also faces its own hurdles, including possible regulation. Regardless, valuations — while difficult to measure reliably — seem stretched for some projects, with many coins not yet in common use with larger market caps than Fortune 500 companies.
But however the above scenarios turn out, if Bernstein’s bubble criteria are met, investors would do well to exercise caution in a fragile market.
