MW Six out of seven conditions are met for a stock-market bubble, this strategist says.

By Steve Goldstein

UBS strategist says it's time to worry if 10-year yield tops 5%

The stock market is not yet in a bubble - but it's getting closer, and six out of seven conditions for one have already been met, a stock-market strategist says.

UBS global equity strategist Andrew Garthwaite put together his bubble checklist, as he compared current conditions to the dot-com bubble of the late 1990s and the Japanese asset bubble of the 1980s.

End of a structural bull market: Check. UBS defines a structural bull market as when equities outperform bonds over a 10-year period by at least 5% per year.

Profits under pressure: Check. Earnings growth is slowing, particularly in cyclical sectors.

Loss of breadth: Check. A handful of technology giants-what UBS calls the 'Magnificent Six,' which excludes Tesla -are driving the market, while smaller stocks lag. The average 12-month forward price-to-earnings ratio of those tech giants such as Nvidia $(NVDA)$ and Apple $(AAPL)$ is 28 and the trailing price-to-earnings ratio is 34.

25 years since the last bubble: Check. It's been roughly 25 years since the dot-com bubble peaked.

"This time is different" narrative: Check. Investors are betting big on generative AI as a game-changer for productivity.

Retail participation: Check. Retail investors are piling into speculative assets, from meme stocks to crypto.

Loose monetary policy: Not yet. Right now there's the opposite of the Greenspan conundrum, since longer-term debt yields have risen even as short-term interest rates have fallen, which undermines the impact of the Federal Reserve's 100 basis points of rate cuts.

He does allow for two possible justifications for a bubble. One would be, essentially, that AI does lead to a big productivity boost, of say 2 percentage points from 2028.

Another point is that if government balance sheets are more risky than normal versus corporate balance sheets, then perhaps the equity risk premium over bonds should be lower, particularly for those companies with strong balance sheets like the big tech giants. Johnson & Johnson $(JNJ)$ and Microsoft $(MSFT)$ each have better credit ratings than the U.S. government, and in Europe, Eni (IT:ENI), L'Oreal (FR:OR) and Generali (IT:G) are among the companies with two notch ratings better than their governments.

Garthwaite says it's time to worry if the 10-year Treasury yield BX:TMUBMUSD10Y exceeds 5% (though UBS forecasts it'll be 4.25% at the end of the year). He said investors should stay underweight non-financial cyclical companies, preferring defensive stocks with low leverage, citing companies including SAP $(SAP)$, Microsoft and BAE Systems (UK:BA).

He does worry about a catch-22 on import tariff policy - to be effective they have to be moderate, but to have maximum bargaining power, President Donald Trump needs to have aggressive rhetoric.

Financial stocks can serve as a hedge on populism, since they're the best performing sector if inflation expectations rise.

In the U.K., UBS sees opportunities in rate-sensitive sectors like utilities and real estate, which are trading at steep discounts.

-Steve Goldstein

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January 23, 2025 05:18 ET (10:18 GMT)

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