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Wealth Insights Podcast 1

January 2023

Is there a bubble in equity markets?

Vasu Menon,
Executive Director,
Investment Strategy,
Wealth Management Singapore,
OCBC Bank

After a strong V-shaped rally in stock markets, it is normal for investors to feel nervous and start worrying about equity bubbles.

This is especially when the economies are on the cusp of a recovery, and corporate earnings have not mirrored the same V-shaped recovery that we have seen in stock markets.

We think that stock markets can head higher, despite the sharp global equity rally over the past 11 months.

Brimming with liquidity

For one, there is still a lot of liquidity on the sidelines. There is significantly more to come from the US$1.9 trillion US stimulus package, and this may exaggerate market movements, as we have seen from the sharp V-shaped rebound from March 2020.

Also, as the vaccine rollout gathers pace, Covid-19 infections are falling. As economic recovery gathers momentum, investor-confidence should pick-up further and this should help stock markets to head even higher.

But corrections are healthy

However, it does not mean that we won’t see intermittent pullbacks in the markets.

Occasional corrections are normal and healthy, even in a bull market. They allow markets, which have been on a tear, to catch a breather before resuming their uptrend.

We saw markets pull back and take a breather recently after US 10-year Treasury yields rose sharply.

Although yields were rising partly because of better economic prospects (which should have been good for equities), stock markets experienced some turbulence because investors were feeling nervous about inflation eroding future corporate earnings, and the higher yields provided an excuse to take some money off the table.

If you look at the global equities rally last year, based on the MSCI World Index, it was interspersed by corrections ranging from 6-8% on three occasions. However, these pullbacks did not signal the end of the bull market.

Instead, on each occasion, global equities regained their footing and resumed their uptrend soon after.

No equity bubble

Looking ahead, the outlook for global equities is still good. We do not see a bubble, at least not for the broader market.

There may be excesses in some segments of global equity markets, but the problem is not widespread.

Eventually, equity markets are driven by fundamentals and valuations. The good news is that the outlook for the global economy and earnings is good, and valuations are generally not excessive.

Also as mentioned earlier, there is a lot of idle liquidity which can offer market support.

In the US for example, there is more than US$4 trillion sitting on the sideline in Money Market Funds, and this is a huge source of liquidity for Wall Street and global equities.

Monetary and fiscal policies are also very supportive of markets.

Both the US central bank and the US government, for example, have unleashed massive stimulus measures over the past year, and they can do more if necessary.

As long as the Covid-19 situation improves, and more people get vaccinated, the investment outlook will continue to improve, and this can fuel further market upside.

What about a tech bubble?

Investors may remember the dotcom bubble in 1999/2000 when tech stocks rallied sharply initially, only to plunge after the tech bubble burst.

So, it’s understandable that they are nervous now about the tech sector, as many tech stocks have done exceptionally well in the past few months, helped by Covid-19 dynamics.

Nevertheless, we feel that tech stocks should remain as a core part of investors’ portfolios.

Technology is poised to drive major, transformational changes in the way individuals and businesses operate in coming years, and even decades.

Technology is clearly a multi-year theme, and unlike the dotcom bubble which burst in 2000, the tech-rally this time around is backed by much stronger fundamental.

For those with a strong risk appetite and a long-term investment horizon, tech stocks can still offer attractive returns and sharp pullbacks can present buying opportunities.

Stay invested

In a nutshell, we do not see a bubble in the general equity market or the tech sector. Instead we see more upside for markets in the medium term.

This is not to suggest that investors should put all their money into equities and ignore other asset classes.

For prudence, it is important to have a diversified investment portfolio, comprising a mix of different asset classes. The exact asset allocation will clearly depend among other things such as one’s risk appetite and time horizon.

For those with strong risk appetites, allocating more of their investments to equities still makes sense at this juncture.

While growth stocks like technology stocks have taken the lead in the rally over the past eleven months, going forward, value stocks which are beneficiaries of the cyclical economic recovery, look set to play catch-up.

This is the equities segment that we are more positive about in coming months.

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