Is US stock market in a bubble?

The last major bubble pop happened in 2008. Lets compare Vanguard VEU ETF that tracks the whole world's stock market excluding US and VTI which includes the US. VEU returned 95% since 2007 while VTI returned 366%. So we clearly see an extreme outperformance of the US stocks. The most important question of today is if US stock market is in a bubble.

Currently US equities weigh in 62% of world's stock market while US GDP only contributes about 25% of world's GDP. The last year that gap increased even faster. Moreover Shiller PE and Warren Buffet Indicator for US stocks are signaling the extreme overvaluation.

Finally to contrast with these valuations the jobs and payroll data was really bad. Take a look at Indeed jobs postings for example:

The only “glimpse of hope” is in PEG ratio of the US stocks. PEG ratio is Peter Lynch favorite indicator and it takes company growth into account unlike PE ratio. As we can see even though SP500 PEG ratio also indicates overvaluation the PEG ratio for all US stocks is much more benign:

Stock prices can grow for many reasons but usually it is the earnings expectations that drive the stock prices. GDP growth is one of the most powerful indicators of economic growth which also usually implies revenue growth for companies. Current US nominal GDP growth is close to 5% which is much less than the growth rate of SP500 companies valuations. Moreover the real GDP growth is much more humble and is around 2%.

So back to the original question: do we have a bubble or the current oversized stock valuations in US are justified? I think this question cannot be answered without a deep dive into monetary and fiscal policy of the US.

This current period in macro economic history unprecedented... We all know that to tackle inflation Fed had to start raising rates in 2022. That caused a mini correction but no major bubbles were popped. Overall economy continued to function normally. I propose the reason for that is Reverse Repo expansion of the magnitude never seen before. Reverse Repo is a fancy Fed mechanism to inject liquidity in overall economy. This way Fed was able to raise rates without causing a massive pain to the market. The excessive liquidity was finding ways into consumer spending, meme stock buying, fartcoin purchases, “the banana on the wall” buying and all other signs of excesses in the economy.

Usually when Fed lowers rates the 10 yr treasury bonds follow as well but we all know that since the first Fed cut in September the 10yr notes misbehaved and we do not know if that misbehavior becomes a disaster. The 10 yr note yield was rising instead of falling indicating the investors were scared of US government ability to sustain the high deficit. The 10yr treasury yield rising could also indicate that investors are worried about hyperinflation as long bonds can become worthless in the event of hyperinflation!

So are we in US stock market bubble? My proposition is that it depends on the choice of the incoming administration. They can literally choose to cause a bubble bust. The bubble in the stock market will bust if the new administration chooses to implement aggressive tariffs and lower taxes without significant cuts to government spending. Such measures will increase the deficit of the government forcing even higher bond yields than today, way beyond 5%. In that scenario we will have an inflationary shock and a lot of stocks will tumble because they won't be able to deliver same returns as risk free rates that cash would be able to deliver.

Now there are factors that convince me that we might not have a bubble bust unless we have it in the next few weeks before the next administration takes over. First of all there are ways to exit current deficit problem in much more benign ways and I do not think people that will run Fed and Treasury are stupid and want a crash. Moreover the world is very different today and we cannot really look too much into historic events for guidance because of a completely different economic structure of the world economy. One of the most important factors is globalisation that should be taken into account. It is very likely that we are witnessing the “Universalization” of the USA. I coined this term and what I mean by that is that investors choose to buy US registered corporations because of relative stability of US as a country due to its size, history and shear power. When investors buy a US registered corporation they buy into lower corporate taxes than in other developed world economies. In 2017 the corporate tax rate was lowered from 35% to 21%. Also US labor laws are very pro-corporate compared to other developed world economies. When investors buy a US registered corporation it doesn't mean they get exposed to US economy only. They get exposed to world economy because most large corporations these days receive revenue from all around the world through subsidiaries. US has it all: cheap money, cheap outsourcing, hyperscaling, language advantage, reputation etc. So if an investor wants to get exposure to lets say industrial machinary they might choose a US corporation due to above reasons even though almost all sales and production capacities of such a corporation are located outside of US. Finally the role of ETFs cannot be ignored. Most ETF issuers such as Vanguard and Blackrock are also US based corporations and worldwide investors buy those ETFs. That is what I mean by “Universalization” of the US stock market.

So in conclusion: unless the next administrations messes up real badly we might have an average 2025 with maybe somewhat weaker performance but still a decent year. The reason why I don't expect great performance from the stock market is simply cash and short bond yields are incredibly attractive and that puts pressure on stock valuations.

Link to the original article with images: https://tickernomics.com/blog.html#19