Are US equity markets in a bubble? - FinanceFeeds

Are US equity markets in a bubble?

Darren Sinden

88.88 % of all S&P 500 stocks are trading above their 200-day moving average

Wall Street NYSE

US equity markets rebounded vigorously from the COVID-19 crash that we saw last March. The S&P 500 index rallied by more than 15.60% over the last 12 months the Nasdaq 100 added more than 45.0% in that period.

Whilst the Philadelphia Stock Exchange SOX index which tracks the performance of semiconductor manufacturers rose by 59.28% over the last year.

Sharp rises in the value of equity indices don’t signify that a bubble has or is forming, because the index performance says nothing specific about valuations or the factors that drove the moves higher. Leaving that to one side for the moment let’s look at some other indicators that can shed light on our question.

If we turn to how US stocks are trading relative to their long term averages we find that in the S&P 500 as whole 88.88% of stocks are trading above their 200-day moving average in fact if we look at all US-listed stocks the percentage trading above their 200-day moving average is very similar at 88.58% the indicator has only ever been higher than this on two previous occasions.

Once again this information does not confirm that a bubble has formed in US equities but it does suggest that as a group they are trading towards the top end of their relative historical ranges.

Looking at valuation metrics we find that US equities are trading at multiples not seen since the boom. The average dividend yield for US stocks is 1.4% the trailing price-earnings ratio for the US stock universe is 33 times earnings. Whilst the forward PE ratio is 24.0 times earnings.

In both cases, the ratios have only ever been higher on one occasion in modern times, and that was during the internet bubble of the late 1990s and early 2000s.

But perhaps the most concerning statistic is the fact the shares of US-listed technology companies, that lose money, have risen in value by almost five times over the last 10 months. As measured by Goldman Sachs’s non-profitable technology index. Whose chart effectively went parabolic during 2020.

Should FX & CFD brokers be concerned about these market moves?

Despite the vast majority of providers being predominantly facilitators of client trades, they are, however, potentially on risk to their clients and should US equity markets fall sharply that could open the door to trading losses.

We can get a flavour of how margin trading clients are positioned in US equities by looking at the trading sentiment indicators provided by IG Group, one of the largest margin trading brokers.

For now, at least positioning doesn’t seem to be extreme, and if anything is tilted to the downside. With 57% of IG clients short of the S&P 500 index and 66.0% of them short of the Nasdaq 100 index. It’s a similar story on the Russell 2000 index, a much broader US equity benchmark, where 67% of IG clients, that have a position in the index, are short of it.

As yet we haven’t seen any signs of stress among brokers or indeed their clients. With both groups seemingly able to make money in 2020 and continuing to trade actively in the early stages of 2021.

Competition among brokers for equity CFD business is intensifying and the products are often the largest profits centre in these businesses.

Whilst most brokers would probably be reluctant to make the first move, is the time coming for the margin requirements, on US stocks, to be raised as a precautionary measure? Because if we are in a bubble and it bursts, history shows us that there will be very little warning if any.

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