The stock market isn’t in a bubble yet, but it’s edging closer, with six out of seven conditions for one already in place, according to stock-market strategist Andrew Garthwaite.
UBS’s global equity strategist developed a “bubble checklist” by comparing current market conditions to past bubbles, including the dot-com bubble of the late 1990s and Japan’s asset bubble in the 1980s.
Key conditions for a bubble:
- End of a structural bull market: Check. UBS defines a structural bull market as one where equities outperform bonds by at least 5% annually over a 10-year period.
- Profits under pressure: Check. Earnings growth is slowing, especially in cyclical sectors.
- Loss of market breadth: Check. A small group of tech giants—dubbed the ‘Magnificent Six’ by UBS, excluding Tesla—are driving the market, while smaller stocks lag. These tech leaders, such as Nvidia and Apple, have forward price-to-earnings ratios averaging 28, with trailing P/E ratios reaching 34.
- 25 years since the last bubble: Check. It’s been about 25 years since the dot-com bubble burst.
- “This time is different” narrative: Check. Investors are betting heavily on generative AI as a game-changer for productivity.
- Retail participation: Check. Retail investors are flocking to speculative assets, from meme stocks to cryptocurrencies.
Loose monetary policy: Not yet. Currently, the opposite of the Greenspan conundrum is at play, with long-term debt yields rising even as short-term rates fall, undermining the effect of the Federal Reserve’s rate cuts.
Garthwaite offers two possible reasons that could justify a bubble. One is that AI could indeed deliver a significant productivity boost of around 2 percentage points by 2028. Another possibility is that government balance sheets are riskier than corporate ones, which could lower the equity risk premium over bonds, particularly for companies with strong balance sheets like tech giants Johnson & Johnson and Microsoft.
Garthwaite suggests that investors should start worrying if the 10-year Treasury yield exceeds 5% (though UBS forecasts it will be 4.25% by the end of the year). He advises staying underweight on non-financial cyclical stocks, favoring defensive stocks with low leverage, such as SAP, Microsoft, and BAE Systems.
He also cautions about a potential catch-22 with import tariff policies—effective tariffs require moderation, but maximum bargaining power needs aggressive rhetoric.
For investors in the U.K., UBS sees potential in rate-sensitive sectors like utilities and real estate, which are currently trading at significant discounts.
