Understanding the market | How similar are the gains of the "Seven Sisters of US Stocks" to the bubble period of Sci-Tech stocks?
The valuation of the "Big Seven" in the US stock market seems too extreme? The cheap and continuously declining interest rates are a prerequisite for the formation of asset bubbles. Currently, the spread between high-grade bonds and US Treasury bonds has narrowed to 86 basis points in the US, while the concentration of US stocks has reached its highest point since 2009.
The continuous fermentation of the AI craze is the driving force behind the continuous rise of the US stock market. Except for NVIDIA, the seven leading technology stocks, including Alphabet-C and Meta, have turned in impressive performance reports, with soaring stock prices propping up the market with their absolute market share advantage. The expectations of Fed tightening and higher-than-expected inflation have also failed to stop the upward trend of the US stock market.
Renowned Bank of America analyst Michael Hartnett emphasized in his latest report titled "A Brief History of Bubbles" that all asset bubbles are built on a solid economic foundation, with cheap and continuously declining interest rates being a prerequisite for asset bubbles. Currently, the spread between high-grade US bonds (investment-grade corporate bonds) and US Treasury bonds has narrowed to 86 basis points, the lowest since 2020. At the same time, the concentration of US stocks has reached its highest level since 2009:
The top 5 stocks in the US stock market have contributed to 75% of the S&P 500's gains so far. The top three tech stocks by market value have accounted for 90% of the tech sector's gains to date. As shown in the chart below, the breadth of the US stock market is currently the worst since March 2009, when the S&P 500 hit a low of around 666 after the Lehman Brothers bankruptcy.
Previously, Hartnett had stated that the rise of the US stock market to historic highs was about to trigger multiple sell signals. As of the week ending February 7th, Bank of America's Bull & Bear Indicator rose to 6.8. When the reading is above 8, it indicates that the rally has gone too far, sending out a reverse sell signal.
J.P. Morgan's quantitative strategist also pointed out that the concentration of US stocks is second only to the dot-com bubble era. By the end of December, the top ten stocks in the MSCI US Index had risen to a share of 29.3%. In the long run, this proportion is second only to the historical peak of 33.2% in June 2000.
How similar is the current trend of US stocks to the dot-com bubble era?
Hartnett pointed out that in addition to concentration, the current rise of the "Big Seven" in the US stock market has many similarities to the dot-com bubble era, including catalysts for the bubble, prices, valuations, and actual earnings:
Catalysts: The bubble is driven by technological innovation and expectations of loose monetary policy by the Fed. The AI bubble is fueled by the continued hot push of the Fed towards Silicon Valley banks and ChatGPT.
Prices: "Bubble" implies a huge increase from trough to peak. In the past 12 months, the average increase of the Big Seven has reached 140%, close to the 180% increase of the Dow Jones index in the 1920s, but has not yet reached the 190% increase of the dot-com bubble.
Valuations: The current trailing P/E ratio of the Big Seven is 45 times, but it has not yet reached the "absurd" valuations of previous bubble peaks: 67 times for the Nikkei at its peak in 1989, 65 times for the Nasdaq Composite Index in 2000 (and the shocking 205 times for the Nasdaq 100), and 60 times for the FAANG at its peak in 2021. Bonds: Whether the bond yield continues to rise is a key indicator of whether the bubble period is coming. Among the 14 stock market bubbles observed, in 12 cases, the bond yield rose when the bubble reached its peak. Generally, a tightening monetary policy leading to a rise in real interest rates is a common catalyst for the "bursting of bubbles." A 4% real interest rate burst the internet bubble, while a 3% real interest rate burst the subprime crisis. Considering the significant increase in global debt levels compared to history, the 10-year real interest rate, currently at 2%, may need to rise to 2.5-3% to end the frenzy for AI.
Bernstein analysts have also warned in a previous report that the valuations of the "Big Seven" in the US stock market are too extreme:
"If the 'Big Seven' in the US stock market are truly unique, then their significant performance may be justified. Unfortunately, this is not the case. On the contrary, more and more signs indicate that investors' enthusiasm for these seven stocks reflects today's speculative, momentum-driven market. However, investors' short-sightedness has led to significant missed opportunities elsewhere."