The author is the founder and chairman of Oaktree Capital Management and the author of “Mastering the Market Cycle: Getting the Odds in Your Side”
Many investors these days are constantly on the lookout for asset price bubbles, worried about a repeat of past booms and busts.
So, I'm often asked if there's a bubble around the hand-held stocks that lead the S&P 500 stock index, the so-called “Magnificent Seven” technology companies that have dominated the index in recent years and are responsible for facing major pressures. unequal shares in its profits.
You can look at valuation parameters to see the bubble but I have long believed that psychological diagnosis is more effective. I look because of irrational excessive happiness – the direct praise of a group of companies or an asset that leads to a great fear of being left out if one fails to participate in the bubble believing that, for these stocks, “no value is too high”. In particular, when I hear the latter, I consider it a sure sign that the bubble is bursting. In short, bubbles are characterized by bubble thinking.
If bubble thinking is irrational, what allows investors to deviate from rational thinking? There is a simple answer: new. This phenomenon depends on another time-honored investment phrase, “this time is different”. Bubbles are invariably associated with new developments, from the 1630s to Holland's enthusiasm over the newly introduced Tulips, to the internet and telecommunications stocks of the late 1990s. Since there is no historical indication of what the appropriate valuation of the innovation might be, there is nothing to bind it to terra firma.
The bubbles I've lived in have all involved new things, many of which were over thought or not fully understood. The appeal of a new product or way of doing business is often apparent, but the pitfalls and pitfalls are often hidden. A new company can completely surpass its predecessors, but investors often fail to realize that even the brightest newcomer can be replaced. Disruptors can be disrupted, either by skilled competitors or new technologies.
In the 1990s, investors were convinced that “the internet will change the world”. It certainly looked that way, and that prediction created a huge demand for everything related to the internet. Ecommerce stocks went public at seemingly high prices and tripled on the first day. There is always a grain of truth beneath all the mania and the bubble. It's just taken too far. The internet completely changed the world, but many of the dotcom companies that rose in the late 1990s bubble ended up worthless.
Being too optimistic about something new leads to pricing errors. Since the participants of the bubble cannot imagine that there is any downside, they often give the price that takes success. In fact, few newcomers can succeed, or even survive.
Stocks trade at multiples of next year's earnings, reflecting the expectation that they will continue to make money for many years. When you buy stock, you buy a share of the company's earnings every year in the future. When a stock is bought at an above-average price over multiple earnings, investors are paying for the companies' profits — even after giving them credit for significant growth — decades into the future.
Today's S&P 500 companies are, in many ways, far better than the best companies of the past. They enjoy great technological advantage and great scale. But persistence is not easily achieved, especially in high-tech fields that are vulnerable to disruption. In bubbles, investors treated leading companies as if they were sure they would maintain their leadership for decades. Some do and some don't, but change seems to be the rule more than persistence.
Is the US stock market too high? It is very rare for the S&P 500 to return 20 percent or more two years in a row. It happened in the last two years, and the S & P 500 to 24.2 percent in 2023 and 23.3 percent in 2024, bringing us to 2025. What is coming?
Warning signs today include the optimism that exists in the market from the end of 2022, the enthusiasm used in the innovation of AI, and the widespread speculation that the top seven companies will continue to succeed. On the other hand, the forward p/e ratio for the S&P 500 is high but not pure at 23.6 times. I also don't hear people say, “no price is too high” and the markets, while overpriced and maybe in a bubble, don't seem underpriced to me.