Is the US stock market in bubble territory?

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The author is the founder and co-chairman of Oaktree Capital Management and the author of “Managing the Market Cycle: Getting the Odds on Your Side.”

Many investors are on the lookout for asset price bubbles these days, concerned about repeating past booms and busts.

So, I often wonder if there’s a bubble around the handful of stocks that have dominated the index in recent years and led the S&P 500 stock index, the so-called “Magnificent Seven.” A disproportionate share of the profits.

You can look at assessment measures to identify bubbles, but I’ve long believed that psychological testing is more effective. No look out For extreme irrational exuberance – outright worship of companies or groups of assets leads to a great fear of being left behind if one does not participate in the bubble, in the belief that “no price is too expensive” for these shares. Especially when I hear the latter, I consider it a sure sign that a bubble is brewing. In short, bubbles are marked by bubble thought.

If bubble thinking is irrational, what allows investors to deviate from rational thinking? There is a simple answer: novelty. This phenomenon is based on another time-honored investment phrase, “This time is different”. Bubbles have always been associated with new developments, from the craze in Holland in the 1630s to the recently introduced tulip, Internet and telecom stocks of the late 1990s. Since there is no historical indicator of what an appropriate estimate of the new thing might be, it has nothing to do with terra firma.

All the bubbles I’ve lived in have included innovations, many of which were either grossly overestimated or not fully understood. The attractions of a new product or business are often obvious, but the holes and pitfalls are often hidden. A new company can completely surpass its predecessors, but investors often do not realize that even a bright newcomer can replace it. Disruptors can also be disrupted by smarter competitors or new technologies.

In the 1990s, investors were convinced that the Internet would change the world. It certainly seems so, and that assumption has fueled a surge of interest in all things Internet-related. The ecommerce stock debuted at seemingly high prices and then tripled on its first day. Beneath every mania and bubble there is usually a grain of truth. It can only be taken so far. The Internet absolutely changed the world, but most of the dotcom companies that boomed in the late 1990s went bankrupt.

Too much optimism in something new leads to pricing errors. Because bubble participants cannot anticipate any downside, they often provide evaluations that predict success. In fact only a few newcomers can prosper or survive.

Stocks sell for multiples of next year’s earnings, reflecting expectations that they will continue to make money for several years. When you buy a share, you buy a future share of the company’s earnings each year. When you buy stocks at above-average prices to get more income, investors are paying dividends for companies — even after giving them credit for high growth — decades into the future.

Today’s S&P 500 leading companies are in many ways better than the top companies of the past. You get huge technological advantages and massive scale. But persistence isn’t easy to come by, especially in high-tech fields that are vulnerable to disruption. In a bubble, investors view leading companies as maintaining their leadership for decades. Some do and some don’t, but change seems to be the law beyond 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 consecutive years. He It happened Over the past two years, the S&P 500 is up 24.2 percent in 2023 and 23.3 percent in 2024, bringing us into 2025. What lies ahead?

Warning signs today include the optimism that has prevailed in the markets since the end of 2022, the enthusiasm for the new AI thing and the widespread assumption that the seven companies will continue to be successful. On the other hand, the forward p/e ratio on the S&P 500 is high but not crazy at 23.6 times. I don’t hear people say “there is no such thing as too high” and while the markets seem expensive and maybe even a bubble to me, they don’t seem like anything to me.