With the stock market in the US and Japan hitting record highs recently, the FTSE 100 nearing an all-time high and the prices of assets such as bitcoin continuing their record-breaking surge, it’s becoming more difficult to ignore murmurs that we may have entered bubble territory.
Even indices such as the Eurostoxx 50 have been approaching record levels recently.
To add to the evidence for too much animal spirit, all of these records are being broken at a time of lofty interest rates (well, lofty by recent historic standards) rather than at a time of easy money.
But our array of DFMs almost unanimously agree that we are not there yet. Their consensus is that high valuations have been justified by solid earnings and that pockets of the market remain under-owned and undervalued, despite the hype surrounding a handful of companies.
With this in mind, Asset Allocator thought we’d take a deep dive into how DFMs are feeling about market valuations right now.
One of the great things about being in a bubble is that you don’t know you’re in one until it pops.
We’ve seen mania in markets for centuries: in tulips, railways, and, in the early 2000s, tech companies.
For James Klempster, deputy head of multi-asset at Liontrust, that clarity of retrospect always arrives too late.
"Clearly, bubbles are readily identified with the benefit of hindsight but due to a combination of factors including greed, hubris and herding, they are notoriously difficult to identify at the time,” he said.
“This shouldn’t come as a major surprise, given they rely on a stream of willing buyers at ever increasing prices; buyers will only remain active while the narrative around an asset class has sufficient credibility to justify the continued purchase.”
Priced for perfection?
He, like many others, defines the term as a substantial rise in the price of a security that can no longer be justified by its fundamentals.
The region that immediately springs to mind is the US, specifically the S&P 500, and more specifically still the ‘magnificent seven’, that dragged the market by the scruff of its neck through 2023 and 2024.
But in recent months the US has been far from alone in seeing lofty markets.
In February the Nikkei 225 posted a record high and the FTSE 100 is nearing that benchmark. The Eurostoxx 50 would need to rise by just a further 6 per cent to break its record high.
Sam Hannon, investment associate at 7IM, said the US was a region which looked fully valued and he was mindful of the ramifications for global equity funds.
“The size of such allocation in the US, in and of itself, is not so much of a concern – after all, it is the largest economy in the world. However, what does concern 7IM is the concentration of just seven stocks within this ‘global’ allocation. With seven stocks forming around 18 per cent of the MCSI ACWI index, this puts investors at risk of any small change in expectations.”
Richard Philbin, CIO of investment solutions at Hawksmoor, pointed out that the size of Nvidia alone is the equivalent of the entire Spanish stock market twice, and that the weight of Apple in the MSCI World is greater than that of the UK stock market.
But such enormous valuations do not necessarily mean the companies are overvalued or that a collapse is imminent, he added.
How so?
Several of the allocators we spoke to believe the companies behind the rally have justified their performance in the form of earnings and that the remaining 493 constituents of the S&P 500 trade at pretty reasonable levels across the board.
Simon Doherty, head of MPS at Quilter Cheviot, said he does not subscribe to the view that the current environment resembles the dotcom era.
“The dominant market positions of these companies, coupled with their formidable barriers to entry, set them apart from the dotcom days,” he said. “Identifying and allocating to those we see as offering the most attractive investment thesis remains our current focus, while similarly exploring opportunities across other areas of the global equity market with the potential to play catch up.”
Indeed that feeling of relative calm among allocators has led to a pick-up in equity allocation among some of them.
The team at M&G said current valuations were justified, the economy remains resilient, and the policy backdrop is more supportive than last year, and they recently told Asset Allocator that that has led to them adding equities to their tactical views as a result.
Where next?
But that doesn't mean all the allocators we spoke to think everything is sunshine and roses.
Alex Harvey, fund manager at Momentum, expressed concern that interest rates falling might push valuations up beyond what the fundamentals dictate due to the large amount of cash invested into money market funds while rates were high.
He said: "I am concerned about the amount of money that has accrued to cash and money market funds in recent years. I am pleased that investors are making their cash work harder for them, but when we do see those first rate cuts, some of that money will start to be recycled into riskier assets, which in turn risks pushing up valuations further creating a ‘Fomo’ investor mindset and a ‘last hurrah’ of sorts.
“In the current US market more than 50 cents of every marginal dollar put into US equities today is passive, which means almost 15 cents of each dollar will be invested in the magnificent seven. The big get bigger, and the big get more expensive, reinforcing the success of a passive approach with little regard for fundamentals."
Harvey said one positive of this could be that this inefficient capital allocation mechanism could create a richer opportunity set for active managers to outperform over the longer term.
However Harvey did not think there was a broad market bubble - saying there was currently "enough on the table" for investors to generate strong returns and maintain a good degree of diversification over the long term.
Pockets of value
Of course a hallmark of a bubble is that almost absolutely everything is going up.
But the allocators we spoke to are in accord that there’s plenty of value to be found in other, less well-loved areas of the market. Two asset classes that are at the forefront of DFMs’ minds are UK equities, and small/mid-cap funds across the globe.
Asset Allocator recently covered how MGIM has taken the largest British exposure of any allocator in our database.
We looked under the bonnet and found a 36 per cent exposure to the UK, equities and gilts combined. Their equity-only side exposure is an eyebrow-raising 23.5 per cent in their balanced portfolio.
Meanwhile, Abrdn is beefing up its small-cap exposure, taking positions through two mandates in particular: Royal London UK Smaller Companies and Janus Henderson European Smaller Companies.
For now at least, it seems as if our allocators will be monitoring the developments in the magnificent seven with a keen interest and little worry.
