Brian Snyder / Reuters
- According to Ray Dalio’s bubble indicator, the US stock market is not dangerously high.
- However, it found that 5% of the top 1000 US companies are in ‘extreme bubbles’.
- It also identified foam in stock prices, new buyers, strength and the use of leveraged financing.
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Ray Dalio’s bubble indicator suggests that US equities are not trading at unsustainable prices and that they could climb higher.
The billionaire co-head of the world’s largest hedge fund, Bridgewater Associates, said in a research note this month that its market meter is at the 77th percentile for the overall US stock market. The readings for the bubbles in the 1920s and 1990s are in the 100th percentile.
However, Dalio noted that 5% of the top 1000 US companies – including several emerging technology players – are currently in an extreme bubble. Yet it is less than half the percentage at the peak of the dot-com boom.
Dalio’s bubble indicator combines six measures of the stock market. They are:
- How high are prices compared to traditional standards?
- Do prices discount unsustainable conditions?
- How many new buyers have entered the market?
- How broad is the sentiment?
- Are purchases with high leverage financed?
- Have buyers made extraordinary long-term purchases to speculate or protect themselves from future price increases?
The Bridgewater CEO’s benchmark shows that US equities are priced at 82nd percentile on traditional benchmarks, and 77th percentile in terms of earnings growth needed to outperform bonds.
The reading for new buyers is in the 95th percentile, mainly due to the boom in small investments. Bullishness is in the 85th percentile, partly due to the ‘extraordinarily hot’ IPO market, which has been boosted by a flood of specialty procurement companies or ‘SPACs’.
Dalio’s benchmark found that leveraged buyouts, fueled by day traders, recorded record volumes of call options on single stocks, in the 79th percentile.
In contrast, advance sales are in the 15th percentile – compared to the 100th percentile in the late 1990s – because the pandemic has suppressed corporate investment and outweighs the number of mergers and acquisitions.
The billionaire indicator of the hedge fund shows that the shares are foaming. However, it is positively optimistic compared to Warren Buffett’s favorite benchmark and ‘The Big Short’ investor Michael Burry’s recent warning that the stock market is ‘dancing to a knife’.