Our Opinion: 2021

The Great Crash of 2021?

US stocks are more expensive than they were prior to the Wall Street crash of 1929 on a cyclically adjusted price/earnings.

Often, the market doesn’t end with some terrible burst of bad news… It ends when things are pretty good, but not quite as good as yesterday. Relief that Covid-19 is finally ebbing thanks to vaccines could give way to the gloomy realisation that the economy is in a bad way.

It is becoming difficult to resist parallels with the dotcom bubble, which burst in spectacular fashion in the year 2000. The technology-focused Nasdaq index has notched up annual gains of around 40% for two years running. Yet this market is split in two. The money surging into the likes of Tesla and bitcoin does look like dotcom-style speculation, but the established tech giants – such as Amazon, Facebook and Google – boast solid earnings. Indeed, so reliable are the profits of big tech that this select club is now often compared to safe-haven assets such as bonds.

It is easy to spot bubbles. The tricky part is predicting when they will end. In 2017 fund manager Paul McNamara constructed a “bubble portfolio” made up of all the assets then widely considered the most overvalued. It included Tesla, Netflix, US bonds and London property. Many of these assets did subsequently dip, but then came roaring back last year. The portfolio has now more than tripled since mid-2017. Before they pop, bubbles can always become more extreme.

There are growing signs of ‘mania’ in the marketplace, but this could only be the beginning of the end. With interest rates and bond yields so low there is still plenty of money available to leap into speculative assets.

While shares in the US and elsewhere look expensive compared with their underlying earnings, they don’t look quite so dear when compared to government bond yields, which are trading at historic lows (and are below zero in many parts of Europe).

With bonds paying so little, yield-starved investors are being forced to put cash into equities. The Biden administration’s plans for a new $1.9trn stimulus package will only add more fiscal fuel to the fire. High valuations follow logically from historically loose monetary policy. Most investors think interest rates will stay nailed to the floor over the next few years, which should mean equity valuations stay high. Indeed, rising earnings forecasts mean that valuations across developed markets have actually fallen back slightly in recent months.

British shares have finally joined the stock-market party. The FTSE 100 enjoyed its best ever start to the year earlier this month and is up by almost 2% so far in 2021. That easily beats America’s S&P 500, which has gained less than 0.5% so far. The British blue-chip index has risen by more than 16% since the start of November. There may be frenzy on Wall Street, but the climate in the City remains more cautious. Many British fund managers are best described as’reluctant bulls’.

All this talk of a bubble sounds strange to British ears. The FTSE remains well short of its pre-pandemic levels despite recent gains and is far cheaper than most other developed markets.

The CAPE ratio is a valuation measure that uses real earnings per share (EPS) over a 10-year period to smooth out fluctuations in corporate profits that occur over different periods of a business cycle. The UK is currently trading on a ration of 13.7. By contrast, with the S&P 500 on a Cape of about 34.

There could be a long way down for US shares.

12th February 2021