Is the US stock market in a bubble?

What you’ll learn:

• What is a bubble?
• Is the US currently in a stock market bubble?
• How to invest in the US.

Owning shares for the long run is a widely accepted conventional wisdom. But what if we’re in a bubble? Here, we discuss whether the US stock market is in a bubble, and what investors should be considering when thinking about share prices.

What exactly is a bubble?

There is no strict, universal definition of what constitutes a bubble. We would argue it’s when crowds deviate from their usual wisdom to become speculative herds, time horizons shrink, and share prices are pushed up to the point where they bear no resemblance to any kind of fundamental reality.

Whether it’s the promise of technological advance (e.g. dot-com bubble in 1999/2000) or the belief that the housing market can’t go down (e.g. Great Financial Crisis in 2008), they’re also often accompanied by a powerful narrative or universal belief.

Are we currently in a stock market bubble?

Of course, this fundamental reality is only ever known with hindsight – by which time share prices have already sharply declined. If bubbles were easy to identify, not only would they probably not exist, but it would be a very profitable endeavour doing so. High share prices are the most oft-cited reason for why the US stock market is in a bubble.

It’s true that current prices are elevated versus history (note that past performance is not a guide to future performance), but assuming they must revert to some kind of historical average is a dangerous (and frankly lazy) assumption.

One of the reasons why share prices in the US should be higher today versus history is because the tech (and related) giants have come to dominate the US stock market. Generally speaking, these businesses have higher returns on capital (a company's profitability and the efficiency with which its capital is employed), lower costs of raising money, and huge growth expectations – all factors which warrant a higher valuation.

Bonds and share prices

Lower bond yields (the return to an investor from the bond's interest payments) usually justifying higher share prices is a commonly cited reason for why valuations should be higher today, but isn’t entirely true. It’s true that lower interest rates, all else being equal, should result in higher share prices.

But not all is equal! There is no strong link between share prices and interest rates. By way of an example, during the dot-com bubble in 1999/2000, valuations reached exorbitant levels in the US but at the same time, interest rates were at much higher levels than they are today.

If we’re not in a bubble, how do you explain the stock market’s swift recovery during a global pandemic?

The short answer is that markets are forward-looking. Rather than looking at the short-term impact of the pandemic, markets are acknowledging the recovery prospects in years to come. Recent economic data has reaffirmed the recovery ahead.

Business surveys have registered strong readings – consistent with strong growth in the near term. Unsurprisingly, the strong data is a reflection of the strong progress made on vaccination rollouts and economies reopening.

The other thing to note is that this recession has been anything but normal (if there exists such a thing). It wasn’t borne out of financial imbalances due for correction, or excessive speculation. It was simply an external shock. Equally, the response from policymakers is hard to understate. Often the scarring of household balance sheets can hinder recovery prospects.

But that isn’t the case this time around (in aggregate). In the US, it’s estimated that disposable incomes went up last year (again, in aggregate), and the Biden administration is looking to provide more relief in the near future.

Investment conclusion

Of course, no one can say with certainty what future expected returns for the stock market will be. However, based on our latest estimates, we still think it’s worthwhile for moderate risk investors to hold a reasonable portion of their portfolios in shares, including the US.

Where to invest

The Findlay Park American Fund, JP Morgan US Equity Income Fund, and the Loomis Sayles US Equity Leaders Fund are just three funds on the Barclays Funds List that focus on the US market. Find out more information on these funds.

To diversify your investment, you may like to consider our own Barclays Ready-made Investments (RMI). The RMI are just one example of a range of diversified funds which allow you to select the level of risk you are most comfortable with. These multi-asset funds invest in passive funds across a range of asset classes and regions, offering a globally diversified solution for investors. Ready-made Investments are not the only funds that we offer and they won’t be appropriate for everyone.

These are our current opinions but the future, as ever, is uncertain and outcomes may differ. Past performance of the fund and its manager are not a reliable indicator of their future performance.

We don’t offer personal investment advice so if you’re unsure you should seek that independently.

Funds are designed for the long term so you should only consider them if you can stay invested for at least five years.

Read the Assessment of Value report [PDF, 683KB]  for funds run by Barclays.