Brian Snyder / Reuters
- Ray Dalio’s bubble indicator suggests that the US stock market is not dangerously high.
- However, it found that 5% of the 1,000 largest US companies are in “extreme bubbles”.
- He also identified foam in stock prices, new buyers, optimism and use of leverage.
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Ray Dalio’s bubble indicator suggests that US stocks are not trading at unsustainable prices and could rise further.
The billionaire co-chief of the world’s largest hedge fund, Bridgewater Associates, said in a research note this month that his market indicator is at the 77th percentile of the overall US stock market. His bubble readings in the 1920s and 1990s are in the 100th percentile.
However, Dalio noted that 5% of the US’s 1,000 largest companies – including several emerging technology players – are currently in “extreme bubbles”. Still, that’s less than half the percentage at the height of the dot-com boom.
The Dalio bubble indicator combines six measures of the stock market. They are:
- How high are prices compared to traditional measures?
- Are prices discounting unsustainable conditions?
- How many new buyers have entered the market?
- How widely optimistic is the feeling?
- Are purchases being financed by high leverage?
- Did buyers make exceptionally extended forward purchases to speculate or hedge against future price gains?
Bridgewater’s chief indicator shows that US stocks are quoted at the 82nd percentile in traditional metrics and at the 77th percentile in terms of the profit growth required to outperform bonds.
Its reading for new buyers is at the 95th percentile, largely due to the retail investment boom. Optimism is at the 85th percentile, partly due to the “exceptionally heated” IPO market, which has been overwhelmed by a flurry of special purpose acquisition companies or “SPACs”.
Dalio’s assessment found that leveraged purchases, fueled by day traders snapping up record volumes of individual stock options, are in the 79th percentile.
In contrast, future purchases are at the 15th percentile – compared to the 100th percentile in the late 1990s – as the pandemic depressed corporate investment and weighed on the number of mergers and acquisitions.
The hedge fund billionaire’s indicator is signaling some foam in the shares. However, he is positively optimistic compared to Warren Buffett’s favorite indicator and the recent warning from “The Big Short” investor Michael Burry that the stock market is “dancing on the razor’s edge”.