The writer is the co-founder and co-president of Oaktree Capital Management and author of Mastering the Market Cycle: Getting the Odds on Your Side
Many investors these days are on high alert in anticipation of asset price bubbles, concerned about a repeat of past booms and busts.
Thus, I'm often asked if there's a bubble surrounding the handful of stocks that have been leading the S&P 500 stock index, the so-called “Big Seven” technology companies that have dominated the index in recent years and been responsible for a significant rise in stock prices. A disproportionate share of their gains.
You can look at the evaluation criteria to spot the bubble, but I have long believed that psychiatric diagnosis is more effective. I He looks Because of the largely irrational exuberance – the outright adoration of a set of companies or assets, leading to an enormous fear of being left behind if one fails to participate in the bubble with the conviction that for these stocks “no price is too high”. In particular, when I hear the latter, I take it as a sure sign that the bubble is brewing. In short, bubbles are characterized by bubble thinking.
If bubble thinking is irrational, what allows investors to deviate from rational thinking? There is a simple answer: modernity. This phenomenon is based on another time-honored investment phrase, “This time is different.” Bubbles are always associated with new developments, from the mania in the 1630s in the Netherlands over recently introduced tulips, to internet and telecom stocks in the late 1990s. Since there is no historical indication of what the appropriate evaluation of something new might be, there is therefore nothing to connect it to established ground.
The bubbles I lived in all involved innovations, many of which were either exaggerated or not fully understood. The attractions of a new product or way of doing business are usually obvious, but the pitfalls and pitfalls are often hidden. A completely new company may outperform its predecessors, but investors often fail to realize that even a bright newcomer can take its place. Disruptors can be disrupted, whether by savvy competitors or even by newer technologies.
In the 1990s, investors were certain that “the Internet would change the world.” It sure seemed that way, and this assumption has led to massive demand for all things Internet. E-commerce stocks went public at seemingly high prices and then tripled on the first day. There is usually a grain of truth behind every obsession or bubble. It's been taken too far. The Internet has certainly changed the world, but the vast majority of dot-com companies that rose in the late 1990s bubble ended up worthless.
Being overly optimistic about something new leads to pricing errors. Since participants in the bubble cannot imagine there being any downside, they often give ratings that assume success. In fact, only a few newcomers will be able to succeed, or even survive.
Shares are selling at multiples of next year's earnings, reflecting expectations that they will continue making money for many years. When you buy a stock, you are buying a share of the company's profits each year in the future. When buying a stock at an above-average earnings multiple, investors are paying for the companies' earnings — even after giving them credit for significant growth — several decades into the future.
Today's leading companies on the S&P 500 are, in many respects, much better than the best companies of the past. They have enormous technological advantages and broad scope. But achieving persistence is not easy, especially in high-tech fields that are prone to disruption. In bubbles, investors treat leading companies as if they are sure to maintain their lead for decades. Some do and some don't, but change seems to be the norm more than persistence.
Is the US stock market too high? It is extremely rare for the S&P 500 to return 20 percent or more for two years in a row. He – she It happened In the past two years, with the S&P 500 rising 24.2 percent in 2023, and 23.3 percent in 2024, taking us to 2025. So what lies ahead?
Warning signs today include the optimism that has gripped markets since late 2022, the enthusiasm being applied to the new thing of artificial intelligence, and the widespread assumption that the Big 7 will continue to be successful. On the other hand, the S&P 500's forward P/E ratio is high but not crazy at 23.6 times. I also don't hear people saying, “No price is too high” and the markets, while high and perhaps frothy, don't seem crazy to me.
