Ray Dalio’s bubble indicator suggests US stocks aren’t trading at unsustainable prices and could climb higher.
The billionaire co-chief of the world’s largest hedge fund, Bridgewater Associates, said in a research note this month that his market gauge is at the 77th percentile for the overall US stock market. Its readings for the bubbles in the 1920s and 1990s are in the 100th percentile.
However, Dalio noted that 5% of the top 1,000 US companies – including several emerging-technology players – are currently in “extreme bubbles.” Still, that’s less than half of the percentage at the height of the dot-com boom.
Dalio’s bubble indicator combines six measures of the stock market. They are:
How high are prices relative to traditional measures?
Are prices discounting unsustainable conditions?
How many new buyers have entered the market?
How broadly bullish is sentiment?
Are purchases being financed by high leverage?
Have buyers made exceptionally extended forward purchases to speculate or protect themselves against future price gains?
The Bridgewater chief’s gauge shows US stocks are priced in the 82nd percentile on traditional metrics, and the 77th percentile in terms of the earnings growth required to outperform bonds.
Its reading for new buyers is in the 95th percentile, largely due to the boom in retail investing. Bullishness is in the 85th percentile, partly due to the “exceptionally hot” IPO market, which has been supercharged by a flood of special-purpose acquisition companies or “SPACs.”
Dalio’s yardstick found that leveraged purchases, fueled by day traders snapping up record volumes of call options on single stocks, are in the 79th percentile.
In contrast, forward purchases are in the 15th percentile – compared to the 100th percentile in the late 1990s – as the pandemic has depressed corporate investment and weighed on the number of mergers and acquisitions.
The hedge-fund billionaire’s indicator is flagging some froth in stocks. However, it’s positively optimistic compared to Warren Buffett’s favorite gauge and “The Big Short” investor Michael Burry’s recent warning that the stock market is “dancing on a knife’s edge.”