- Ray Dalio’s bubble indicator suggests that the US stock market is not dangerously high.
- However, it has been found that 5% of the first 1,000 American companies are in “extreme bubbles”.
- It also identifies the foam in stock prices, new buyers, the bullish way and the use of leverage.
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The joint chief of the billionaire of the largest hedge fund in the world, Bridgewater Associates, said in a research note this month that his market index is at the 77th percentile of the total US market. His bubble readings in the 1920s and 1990s were in the 100th percentile.
However, Dalio noted that 5% of the top 1,000 US companies – including several players with emerging technologies – are currently in “extreme bubbles”. And yet this is less than half the percentage at the height of the dot-com boom.
Dalio’s bubble indicator combines six stock market indicators. They are:
- How high are the prices compared to traditional measures?
- Are discount prices unsustainable?
- How many new buyers have entered the market?
- How wide are the moods?
- Are purchases with high leverage financed?
- Have they bought extremely extended forward purchases to speculate or guard against future price increases?
The measurement by the Bridgewater boss shows that US stocks are valued at the 82nd percentile of traditional indicators and the 77th percentile in terms of earnings growth needed to outperform bonds.
Its reading for new buyers is in the 95th percentile, largely due to the boom in retail investment. The bull is in the 85th percentile, in part because of the “extremely hot” IPO market, which has been compressed by a stream of special purpose vehicles or “SPACs.”
Dalio’s criterion found that leverage purchases fueled by day traders, which intercepted record volumes of single-share call options, were in the 79th percentile.
In contrast, forward purchases are at the 15th percentile – compared to the 100th percentile in the late 1990s – as the pandemic has reduced corporate investment and estimated the number of mergers and acquisitions.
The hedge fund indicator for a billionaire shows some foam in stocks. However, this is positively optimistic compared to Warren Buffett’s favorite gauge and the recent warning of The Big Short investor Michael Burry that the stock market is “dancing with a knife”.