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How I learned to stop worrying and love the bubble

Market frenzy across the Atlantic needn’t trouble investors closer to home
March 4, 2021

Paul Wallace is right to ask whether we are in bubble territory. Warnings over the soaring US stock market have been getting steadily louder since prices rebounded sharply from their Covid-induced swoon a year ago. Mass retail stock-picking, rocket-powered price rises and extremes of valuation suggest trouble ahead. With most economies still to open up after the pandemic, activity could get a lot more frenzied before it runs out of puff.

For most of us, the big question is: does this matter? It is clearly possible that a bubble of alarming proportions is forming in the US. According to the asset manager Schroders, US stocks currently trade at 4.5 times the value of their assets, against an average over the past 15 years of 2.8 times. 

For investors outside the US this does matter, since to some degree we are all in Wall Street’s orbit. The US has a 60 per cent weighting in global equity benchmarks. If this bubble bursts, everyone will get hurt. This is not a moment to be adding exposure to US markets. 

But our view of finance in the UK and elsewhere is often skewed towards the US perspective by the weight of coverage it receives. This can obscure opportunities in other markets that are nowhere near bubbling over.

Research Affiliates, a US analyst, has called UK value shares—companies that trade on modest valuations—the “trade of the decade,” thanks to the Brexit resolution and rapid progress with vaccinations. GMO, a firm led by respected investor Jeremy Grantham, is extremely gloomy about the US outlook but sees a bright spot in “Emerging Market Value”—reasonably priced shares in large firms based in faster-growing economies. It suggests these will return a healthy 5 per cent a year after inflation over the next seven years.

For those attracted to Emerging Market value, there is an iShares exchange traded fund that offers easy access to companies fitting this description. But one warning: since these firms tend to borrow in dollars, they have been helped recently by a relatively weak US currency. If it strengthens, their borrowing costs will rise, hitting their shares. 

It is an important caveat, but options such as these still look a reasonable response to a US market that is prodigiously expensive—if not yet in a bubble of epic proportions.