Revisiting Historical Bubbles

Bank of America Chief Market Strategist, Michael Hartnett, has drawn an intriguing parallel between the current surge in the U.S. “Magnificent Seven” stocks and historical market bubbles stretching back to the 18th century.

Hartnett’s insights reveal that while every bubble is unique, they share common catalysts such as technological innovation, new markets, and, notably, central bank easing. These elements have historically converged to inflate asset prices beyond sustainable levels.

The AI bubble, for example, was ignited by the Federal Reserve’s response to Silicon Valley Bank’s collapse and the subsequent rise of ChatGPT. This scenario mirrors past bubbles such as the Plaza Accord’s effect on Japan and the internet bubble fueled by the Long-Term Capital Management (LTCM) crisis. Similarly, policy stimuli in response to the COVID-19 pandemic inflated crypto and tech stocks, reminiscent of the Mississippi and South Sea Company bubbles sparked by changes to English usury laws in 1714.

Such historical context highlights the potential risks that come with rapid market surges.

The Magnificent Seven’s Remarkable Rally

The term “Magnificent Seven” refers to today’s leading U.S. tech giants: Microsoft Corp. (MSFT), Apple Inc. (AAPL), Alphabet Inc. (GOOG, GOOGL), Amazon.com Inc (AMZN), Meta Platforms Inc. (META), NVIDIA Corp. (NVDA), and Tesla, Inc. (TSLA). These companies’ stocks have seen a remarkable 140% gain in the past 12 months.

This surge is approaching historic proportions, nearing the 180% rise of the Dow Jones in the 1920s, surpassing the 150% gains of the Nifty 50 in the ’70s and Japan’s stocks in the ’80s, but still shy of the 190% increase during the internet bubble and the 230% surge in FAANG stocks from COVID-19 pandemic lows.

Investors are now contemplating whether such an unprecedented rally is sustainable without facing a market correction.

Imbalance and Concentration

Hartnett has highlighted a significant concern regarding the concentration of market gains. The top five stocks have contributed to 75% of the S&P 500’s year-to-date (YTD) gains, with the top three tech stocks alone accounting for 90% of the tech sector’s YTD growth.

Furthermore, the current “breadth” of the U.S. equity market, measured by the ratio between the cap-weighted S&P 500 and the equal-weighted S&P 500, is at its worst level since March 2009, suggesting a potential lack of diversity and a high level of concentration in certain stocks.

Indicators of a Bursting Bubble

Historically, rising Treasury bond yields have signaled the peak and subsequent pop of market bubbles. In 12 of the 14 bubbles observed, increasing yields were a precursor to a market downturn.

The real yield on a 10-year Treasury Inflation-Protected Security (TIPS) currently stands at approximately 2%, a figure that has not yet reached the threshold anticipated by Hartnett to trigger the bursting of the Magnificent Seven’s bubble. However, given the global debt’s current unprecedented levels, a modest increase in 10-year real rates to 2.5%-3% could precipitate the end of the current AI and Magnificent Seven mania.

Investors are eagerly watching these indicators to gauge the resilience of the current market momentum and the potential for a correction.