While many parts of the market are showing signs of “irrational exuberance” that should alarm some investors, UBS’s Mark Haefele says there are still some risk assets outside of bubble territory.
“All of the bubble preconditions are in place,” he explained in a Friday note, citing record low financing costs, new participants entering into the market, and a combination of historically low interest rates and high savings rates from government stimulus that’s left investors who are searching for returns with no alternative but equities.
However, Haefele said that while parts of the market seem speculative, investors shouldn’t worry that the whole market is in a bubble.
“The cryptocurrency markets are exhibiting signs of excessive speculation and the IPO/SPAC markets are the hottest in two decades. But these markets do not yet pose a broader systemic risk,” the chief investment officer of global wealth management said.
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Bitcoin Cash (BCH)
Within the IPO and SPAC market, as well as crypto, prices are discounting future rapid price appreciation, a factor that’s typically present during market bubbles, said Haefele.
Speculation is pushing up prices for bitcoin, especially as major investors raise their long-term price targets for the coin, like Guggenheim’s Scott Minerd who sees bitcoin hitting $400,000 in the future.
First-day IPO performance is also the strongest in around two decades. Airbnb leaped 115% on its first day of trading, while DoorDash opened 78% higher than its offer price. SPACs raised more than $70 billion in 2020, more than the entire prior decade combined, he said.
But equities as a whole are not in a bubble, said Haefele. For one, he explained that large parts of the market are not expensively valued by historical comparison. Removing Facebook, Amazon, Apple, Microsoft, Netflix, and Google, the S&P 500 only rose 6% in 2020.
He also said that valuations of indices look reasonable against the backdrop of low interest rates, and used an equity risk premium approach to explain why stocks still look cheap relative to bonds.
Against that backdrop, he recommends investors “think beyond the bubbles.”
“One reason that bubbles can be so deceptive is that there is often a grain of truth behind their narratives. The dotcom bubble, for example, correctly anticipated the impact of the internet,” said Haefele. “Many of the narratives linked to today’s bubbles may also prove to be correct. Investors may be able to capture some upside but reduce the risk associated with bubbles by identifying the narrative, yet investing in a more diversified way.”
He reiterated his suggestion to investors to buy emerging technology investment themes like 5G, fintech, greentech, and healthtech, while staying diversified. He also said UBS is bullish on emerging market stocks.