• The U.S. equity market, represented by the S&P 500 index, was off 0.1% for the week.
  • There has been some chatter about US technology stocks entering “bubble” territory, despite strong underlying earnings growth. Has the market and its mega-cap tech constituents earned such a moniker?

Ray Dalio, famed founder of the storied hedge fund Bridgewater, recently argued why US stocks are not in a “bubble”, contrary to recent rumblings from other prominent investors. He constructed a “USA Equity Market Bubble Gauge” based upon traditional measures of value, broad market sentiment, the use of debt to finance stock purchases, and a few more metrics. Here is how Mr. Dalio’s gauge reads:

Source: Ray Dalio, February 29, 2024

Not very bubbly.

Some arguing that a bubble is forming point to tech stocks such as NVIDIA, a fabless semiconductor company riding the current wave of corporate AI spending. NVIDIA’s price-to-sales ratio stands at a whopping 38 times sales. That valuation looks pricey… but then again, NVIDIA’s gross profit margin is an astounding 77%, and sales have exploded. There are fundamentals supporting that valuation.

John Authers at Bloomberg made a salient point this week on the situation: what if the fundamentals – the earnings – are in a bubble, not the valuations? Reflecting upon market history, Mr. Authers noted that US banks’ revenues doubled in the three years prior to the Great Financial Crisis, an unusually high rate of growth for boring old banks. Thus, at the time, their valuations looked fine.

There was a massive credit bubble that drove those revenues, and when the credit bubble burst, that spelled doom for bank earnings. The rapid ramp-up in borrowing made private sector balance sheets precarious and proved to be an unsustainable source of corporate profits. 

The same phenomenon occurred in 2000, when tech earnings were in a bubble (along with their valuations). An expansion in private sector credit in the 1990’s helped boost corporate profits, although not quite to the same extent as it did in the run-up to 2008.

The other interesting macroeconomic feature of those “dot-com” years was that the US government fiscal balance was in surplus. From 1998 to 2001, the federal government taxed more than it spent. In 2001 the economy entered a recession, and the US fiscal balance turned to deficit where it has been every year since.

Macroeconomic conditions today appear to be the opposite of the dot-com era and the run-up to the Great Financial Crisis of 2008. In the aggregate, private sector balance sheets are strong. There is not much evidence of rising debt service problems at US companies. The government deficit, on the other hand, is currently quite large, continuing the post-2020 trend. The deficit is unusually high given low unemployment and robust economic growth, conditions normally associated with low fiscal deficits.

There is some nuance to the federal deficit. The fiscal budget is a political issue, but the fact remains that a government deficit is a source of corporate profits. Whether this is sustainable is, again, mainly a political question. Given the overall macroeconomic backdrop, perhaps it should not be surprising that corporate fundamentals look good. It also partially explains high post-COVID era profit margins, including those for firms like NVIDIA.


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