Is The Stock Market In A Bubble Right Now?

Key Takeaways

• The US stock market has made big gains so far this year off the back of AI and efficiency moves from big tech
• The rapid growth against a mixed economic backdrop has some analysts questioning whether we’re entering bubble territory
• But not everyone sees that as a negative, with GMO executive Ben Inker saying that a crash would be a “wonderful, generational opportunity to make money”

After a horrible 2022, the US stock market has been soaring so far in 2023. The S&P 500 is up 15.36% year to date, while the tech focused Nasdaq Composite has gained a whopping 31.69% since January 1st.

There have been a number of reasons behind the surge, from (somewhat paradoxically) mass layoffs giving shareholders confidence of improved profitability to the hype around AI boosting tech stocks.

But there’s no getting away from the fact that behind all that is an economy that is throwing up mixed data, to say the least. The job market has remained incredibly strong, but cost of living has risen substantially and interest rates have been put up significantly to combat it, which has frozen the housing market in its tracks. All the while wage growth still isn’t keeping pace with inflation.

So does this rally have the legs to continue for the long term, or is the current bull market nothing but hot air? Let’s look at the details.

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The argument for a stock market bubble

There are a lot of different circumstances that can lead to a bubble. One of the classic bubbles we’ve seen in recent years has been crypto, which has gone through phases of massive growth based on little more than Tweets, TikToks and celebrity hype.

The bubble created multi-millionaires practically overnight, and when it popped it took down an entire industry. Many, many companies have gone bankrupt, mass fraud has been uncovered and a ton of high profile players in the space have been arrested. Yeh, pretty dramatic stuff.

Just because prices rise quickly doesn’t necessarily mean we’re definitely in a bubble, but the hype around AI right now has some very clear parallels to the crypto mania of a couple of years ago.

The noise has quieted a little in recent months, but from the release of ChatGPT to around May 2023, the number of AI announcements, startups and new ‘AI experts’ exploded. As a company who’s been in the AI game for years, it’s clear to see that many of these wouldn’t last long.

So, the case for a bubble is that the hype around AI has driven valuations far above what they should be. While this is focused in tech, that sector is so big that it tends to sway markets.

Renowned investor Jeremy Grantham, a man who predicted the 2000 dot com crash and the 2008 financial crisis, believes that this is all just part of a wider “super bubble” that spans the stock market, real estate and even commodities.

“We had a very complicated but fairly standard-looking superbubble, losing air in the traditional way, right up to this recent rally,” he stated to the Wall Street Journal.

The argument against a stock market bubble

But AI is different to crypto, in that there are very real use cases and substantial adoption already. AI and machine learning has already been used for decades in almost every industry imaginable, and rather than being the discovery of a new technology, ChatGPT simply packaged it in a new way.

There are most certainly going to be startups and AI features that fall by the wayside, but as Amazon CEO Andy Jassy recently said, this current iteration of generative AI will move from a “hype cycle” to a “substance cycle.”

That is to say that some of the air might come out of the market, but what’s left will be only the best and most valuable applications of the technology, which can continue to drive real shareholder value.

From a macroeconomic standpoint, there’s also some compelling evidence to suggest we’re in a pretty strong place. Despite the Fed’s most aggressive rate policy since the 1980’s, the job market remains incredibly strong.

The ADP jobs report for June has just been released, with the figure almost double both the predicted figure and the number from the previous month. It’s a huge result that shows employers are still hiring new staff at a high level.

How investors should navigate bubbly waters

As with any market cycle, there’s really no way to know for certain exactly when and if a bubble will burst, or if we’re even in one at all. Even if we are, a bubble can inflate for many years before it eventually does come crashing down, and those who sit on the sidelines can miss huge gains in the process.

Not only that, but a market crash isn’t necessarily a bad thing for those with a long term view. Ben Inker, co-head of asset allocation at global asset management firm GMO recently made a comment in an interview with the Wall Street Journal, saying that a market crash now would be a, “wonderful, generational opportunity to make money.”

So for retail investors, the plan is simple. Have a long term view, ride the wave of any bubble that appears and pick up gains in the process, and if possible look to capitalize on a crash when it happens.

The bottom line

Bubbles come and go and there are likely to be dozens that burst in the space of a lifetime. Far from being a bad thing, asset bubbles can create huge amounts of wealth, even if they are swift and backed by nothing. Just look at crypto.

The key is to keep a diversified approach to markets to ensure that you are ruined when the inevitable pop comes.

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