Are We in a Market Bubble?

ARE STOCK VALUATIONS TOO HIGH to allow for future returns? Could a correction be coming? And why do the markets seem so disconnected from the economy? “These are some of the key questions we’ve been getting from investors recently,” says Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank.

They’re not surprising, considering that the S&P 500 and other indexes reached all-time highs in February.¹ But while investor concerns are understandable, Hyzy believes, markets are not as “disconnected” as they may seem. In fact, the strong performance likely reflects massive government stimulus and market confidence in economic growth moving forward. “We believe we’re in the early stages of a new business cycle potentially spanning multiple years,” he adds. Though periodic volatility is inevitable, “our data shows that economic activity, corporate earnings and other fundamentals are likely to continue to improve, and we see potential opportunities for long-term investors.”

Below, Hyzy and Marci McGregor, senior investment strategist for the Chief Investment Office (CIO), Merrill and Bank of America Private Bank, provide further insights on how investors can navigate current market conditions.

Should I consider waiting for a better time to invest?

"The phrase ‘all-time highs’ can discourage those who have cash they could be putting to work,” McGregor says. “Instead of investing, they wait for the perfect entry point.”

Yet while past performance doesn’t guarantee future results, history suggests little penalty for investing during elevated markets, McGregor notes. In fact, since 1871, buying into the market when it closed the year at all-time highs produced 15% returns, compared with 10% during other years.²

Meanwhile, “staying on the sidelines can be costly,” she notes. During the 2010s, when S&P 500 returns totaled 190%, missing just the 10 best days of the entire decade would have reduced that return to 95%.³  One way to help mitigate the impact of price fluctuations when you invest is through dollar-cost averaging, which involves investing at regular intervals over time. This strategy helps investors acquire more shares when prices are lower, and fewer when prices are high.

Could the recent social-media-fueled spike in certain stocks be a sign of things to come?  

A wave of retail buying in late January drove up the price of some individual stocks, forcing hedge funds and institutional investors who had been short-selling those stocks to sell other assets. “That led to a vicious downward cycle that pulled the S&P 500 down by 3.3% for that particular week,” Hyzy says. As unsettling as it was, “we expect the effect on the broader equity market to be short-lived,” he adds, in part because the companies in question were small relative to major companies that dominate market listings.

Still, that event and the possibility of future disruptions underscore the risks in attempting to “time” markets through rapid buying and selling and the importance of a patient, disciplined investment strategy. “Short-term volatility is one reason we refer to investing as a marathon rather than a race,” Hyzy says.

Where should I consider investing when markets are high?

With interest rates low and the U.S. and global economies now on the mend, “we maintain our preference for stocks over bonds,” McGregor says. While we believe stocks of large, dividend-paying U.S. corporations remain attractive, now may also be a good time to consider filling “gaps” in a portfolio. That could include smaller-cap and value stocks (stocks of companies with solid fundamentals that have historically underperformed), both of which are currently showing signs of promise, as well as international stocks.

“Investors may also want to consider stocks related to some of the major global themes we see developing in the years to come,” McGregor says. “These include areas such as artificial intelligence, robotics, factory automation, 5G wireless technology, healthcare infrastructure and technology, climate change, cloud computing and big data.” Before making any investments, be sure they fit with your underlying financial strategy, risk tolerance, time horizon and cash-flow needs,” she adds.

What should I discuss with my financial advisor?

Work with your advisor on a long-term investment strategy built around your goals, Hyzy suggests. That strategy should include rebalancing where appropriate, especially when markets are volatile. “A disciplined approach can help you avoid giving in to fears over volatility or making hasty investment decisions and stay focused on the larger trends that are beginning to take shape,” he adds. “That, in turn, helps to raise the probability of reaching your long-term financial goals.”  

For more insights, read “A Marathon Not a Race” and “Investing at Stock Market Highs” from the CIO.