Capital perspectives: Take ‘bubble risk’ off the list of stock market concerns

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With the heady stock market gains of 2023 and early 2024, there has been a lot of talk about bubbles in the general stock market commentary recently.

Given this, my most recent column titled “Stay invested for long-term success” attempted to draw some lessons from the dot-com bubble era of the late-1990s.

The key point: While the S&P 500 fell by half peak to trough once that bubble burst, it never fell below its Dec. 5, 1996 level when then Fed Chair Alan Greenspan coined the term “irrational exuberance.”

The key takeaway: Although making tactical portfolio adjustments can be prudent, all in or all out sort of decisions should be avoided. Said another way, avoid market timing.

Given the concentrated nature of last year’s stock market return, my first two columns of this year discussed the significance of the Magnificent 7: Microsoft, Apple, Amazon, Nvidia, Alphabet (f.k.a. Google), Meta (f.k.a. Facebook) and Tesla, wherein it was noted that, combined, these companies then constituted about 28% of the S&P 500. Note: There has been a great deal more dispersion in the market fortunes of the above-named companies in 2024. For example, Schwab’s Chief Investment Strategist, Liz Ann Sonders, noted in a March 5th webcast that while Nvidia ranks at the top of the year-to-date S&P 500 performance leaderboard, Apple and Google rank sub-400 and Tesla is very near the bottom.

So, for better or worse, the characteristics of an S&P 500 index fund have migrated somewhat towards being a concentrated exposure to these large tech companies and away from its original selling point of being a low-cost way to gain a diversified exposure to large American businesses. Therefore, any broad stock market bubble call must incorporate a highly negative view of the investment merits of these companies.

Here is how I would summarize my thoughts shared in those prior columns as it pertains to the market valuation of the Mag 7 companies: In aggregate, while valuation levels are not bargains, they also do not appear to be representative of a bubble that must, at some point, burst. Going beyond my valuation commentary, the team at DataTrek Research (hyperlink for online has done some excellent work on this “bubble question” in recent weeks.

For example, in their March 3 report, it was noted that “Calling a stock market bubble is difficult using just valuations, but there are other signs that can help spot speculative excess. Outsized first day returns during a heavy IPO calendar is one signal. Landmark M&A deals are another. Tech stocks doubling in a year is a third. Good news: none have occurred yet. Bad news: even non-bubble markets can see drawdowns.”

Additionally, looking back at periods that we can say with 20/20 hindsight were bubbles, the following was shared on Feb. 26: “Over the last 3 years, the S&P 500 is up 31 percent on a price return basis. This is almost spot-on its average 3-year return since 1974 (29 percent). Since the 1970s, stock market bubbles have come with far higher 3-year returns, always peaking at +100 percent. We are nowhere near that level now, which says investor confidence has not reached an unhealthy maximum. This does not guaranty further gains, but we can safely take ‘bubble risk’ off the list of stock market concerns.”

It is important to contrast the Magnificent 7, with their mostly dominant market positions and real earnings, with more speculative corners of the market. Barring some major development, I expect that contrast to be the subject of my next column.

Chas Craig is president of Meliora Capital in Tulsa (www.melcapital.com).