Are US Stocks in Bubble Territory?

July 7, 2021 at 08:26 PM

During the last few weeks, the S&P 500 and Nasdaq 100 indices have been pushing to new record highs, while the Dow Jones is lagging a bit. The S&P 500 index has not been this high in over the last 4 years. 

Historically, the market has only been more stretched than it is now, five times. And only once did stocks continue to rally by a lot – 36% at the height of the Tech Bubble in 1999. That’s when equities almost always correct 10%.

The chances are quite high that stocks will decline 10%. However, this time it may be different. It may be different due to the actions of the Federal Reserve (Fed) and other central banks that are pumping insane amounts of money into the markets each month. Additionally, between 1913 and 2020, the Fed never bought corporate bonds or corporate bond exchange-traded funds (ETFs). And yet, in 2020, the Fed did all of those things, and it continues to do so in 2021.

The current bullish momentum in stocks is powerful, and it would be unwise to start shorting the market because it is overextended and overbought. Stocks can rally another 5-15% without a problem, wiping the accounts of people who are short. 

For those who think that equity markets are in a bubble, it is better to wait for a reversal signal before executing short positions. Such a signal could be a bearish pin bar on daily/ weekly, a strong divergence between some indicators and the price, a double/ triple top pattern or just general exhaustion of the bull market when the price stops pushing to new highs. 

However, we haven’t seen such signals yet. Maybe there will be some positive changes in August at the Jackson Hole conference, where the Fed will announce its plans. Until then, the outlook remains bullish, and even though equities are in a giant bubble, it looks like the bubble will not burst anytime soon.

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