By Joseph Adinolfi
One factor has been present at practically every previous bubble peak
U.S. stocks aren't in a bubble - at least not yet, according to a team of analysts at TS Lombard.
While stocks are certainly looking frothy, they're missing one key ingredient that has been abundant at practically every preceding bubble peak: leverage.
Instead of shooting higher in the aftermath of the nine-month-long bear market that ended in October 2022, margin debt has barely budged, the TS Lombard team pointed out in a report shared with MarketWatch on Wednesday.
In fact, as stocks have advanced, the amount of margin debt compared with the market capitalization of the S&P 500 has actually shrunk.
The relative lack of leverage doesn't mean, however, that stocks aren't expensive. Valuations for technology stocks are currently 1.6 standard deviations above their 7.5-year average, based on expected earnings, meaning they're high compared with recent history. Financial stocks and healthcare stocks are looking even more stretched, trading 1.7 and 2.6 standard deviations north of their cyclical average.
Meanwhile, the S&P 500 index is presently valued at 1.1 standard deviations above its cyclical average. That's based on a forward price-to-earnings ratio - a commonly used valuation metric that compares a company's market capitalization against its expected full-year income - of 21.1, according to TS Lombard.
Fortunately for stock-market bulls, high valuations have been accompanied by strong earnings growth, driven mostly by the largest companies.
"High multiples mean that for further price gains to be made, earnings will have to keep coming in strongly. However, that is what we are seeing and valuation is not a catalyst for downside," said the TS Lombard team, led by director of macroeconomic strategy Skylar Montgomery Koning.
Divergence in earnings growth between market leaders like Nvidia Corp. (NVDA) and the rest of the market has intensified, helping to account for the outsize appreciation in market capitalization of the so-called tera caps - a group of stocks with market capitalization north of $1 trillion that includes Nvidia Corp., Apple Inc. (AAPL), Microsoft Corp. (MSFT), Amazon.com Inc. (AMZN), Meta Platforms Inc. (META) and Alphabet Inc. (GOOGL).
On the one hand, this has caused the U.S. market to become increasingly concentrated: The 10 largest companies comprise more than 30% of the total value of the MSCI USA Index XX:984000, an index that includes both large-cap and midcap stocks. That's the largest share since the dot-com era.
But beneath the surface, breadth has slowly started to improve. Case in point: The share of S&P 500 SPX companies trading above their 200-day moving average is close to 80%.
Margin debt stood at $702 billion as of the end of January, according to the latest data available from Finra, which tracks margin debt.
Margin debt isn't the only source of leverage in markets. Many strategists have speculated that elevated options trading, particularly demand for bullish call options, has helped drive stocks higher.
TS Lombard disputes this notion, arguing that while the volume of call options traded has increased recently, it remains well below levels associated with the market froth of 2020.
The TS Lombard team are hardly alone in dismissing the notion that U.S. stocks are in a bubble. Just last week, Bridgewater Associate founder Ray Dalio argued in a LinkedIn post that the market "doesn't look very bubbly."
See: Why the stock market 'doesn't look very bubbly' to Ray Dalio right now
U.S. stocks were trading higher on Wednesday following a sharp tech-led selloff one day earlier. The S&P 500 was up 0.4% at 5,100 in recent trading, while the tech-heavy Nasdaq Composite COMP was up 0.6% at 16,033.
The Dow Jones Industrial Average DJIA rose by 36 points, or 0.1%, to 38,625.
-Joseph Adinolfi
This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.
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03-06-24 1525ET
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