15 Dec 2021 3 min read

Is this a bubble or did Santa just come to town?

By Emiel van den Heiligenberg

We've seen a significant rally in equities recently, which almost nullifies the drawdown we saw in late November. Though I have been wrong before on Santa's generosity for equity investors, I think this could well be the beginning of yet another Christmas rally.

We have been positive on risk over most of 2021 and we remain bullish equities for the coming year as well. Our research indicates that even being in the late cycle need not be bad for risk assets, as long as recession risk remains low. Our economists think that this risk is very low indeed, and we believe that our proprietary indicators should give us a good read on when that danger is increasing.

The pushback we get on our equity view is that markets are expensive, and some pundits go as far as proclaiming that markets are in a bubble. Let’s start with the valuation point.

Usually equity bears will quote frightening statistics based on absolute valuations in the US, like price/earnings (P/E) ratios. We don’t disagree with the data as such. The US market is the most expensive developed stock market; absolute P/Es are above long-term averages, or even in dangerously expensive territory.

We have two counterpoints. First, P/Es have been trending down – as they should when the cycle matures – and we expect some further contraction. But given that we expect healthy profit growth to outweigh this valuation effect, we have a positive return expectation for equities.

Second, we believe absolute valuations are the wrong indicator on which to focus. It is not absolute valuations that matter for markets, in our view; it’s relative valuations, like the equity risk premium. Many investors need to invest their money somewhere. If bonds deliver a low or even negative return, that matters for the valuation of all other asset classes as on the margin, money moves further up the risk curve to find a decent return.

The TINA effect

The bubble argument is interesting and less misleading than the valuation one. As many readers know, I’m a bit of a bubble buff. I have constructed an index over the course of my career to tangibly measure the risk of a market bubble. The latest version of the Heiligenberg Index is in the chart below, and it’s starting to get exciting. The level of the index is the highest it has been since 2007, albeit on a quite stable level for the past year.

We can’t dismiss that the preconditions of a bubble formation are in place. It’s a bit like we are mid-1990s. The backdrop of low bond yields and ample liquidity creates a TINA effect (“There Is No Alternative”) for old and new investors, via platforms like Robinhood, who see little alternative but to invest in equities and drive up asset prices.

So, for now I see the Heiligenberg Index more as providing a bullish argument. Participating in the formation phase of a bubble can be extremely profitable. I believe we are still in the early stages as several conditions of a bubble are not yet met. There is still plenty of money on the side lines, leverage is low, and – although stock-market enthusiasm among retail investors and the media is increasing – we are nowhere near the frenzy we saw in the 1990s.

Emiel van den Heiligenberg

Head of Asset Allocation

Emiel is responsible for the overall strategic direction of the team’s investment and business strategy. He claims to have been a promising lightweight rower at university until French fries got the better of him. Reflecting his love for rowing in a team, he firmly believes that excellence can only be achieved by a great team made up of motivated individuals that are also eager to work together. To this end he is the self-proclaimed inventor of the verb 'teaming' to acknowledge that shaping a top team and culture of excellence is an ongoing process. Outside of work-family obligations, Emiel’s spare time is filled by a passion for shark diving and skiing. Prior to dedicating his career to portfolio management in 1996, Emiel worked as a policy adviser in the Dutch Ministry of Finance and he graduated from Tilburg University in the Netherlands ages ago. When not glued to his Bloomberg screens, this Dutch man is hooked on computer games, peanut butter and his favourite dark beer made by Belgian monks.

Emiel van den Heiligenberg