As a value investor, I aim to buy into good businesses at sensible prices. As US fund manager Peter Lynch remarked, “A share is not a lottery ticket. It’s part-ownership of a business.” Today, I think the UK FTSE 100 offers outstanding relative value. In particular, big Footsie companies paying chunky dividends look under-priced to me. However, when day traders play the market like a lottery, I fear market bubbles and worry about a possible stock market crash. Looking at today’s frothy prices, can the 12-year bull market in US stocks continue much longer? Alas, when the US market sneezes, UK shares catch a cold. Here are two warning signs that worry me today.
1. Stock market crash? The US tech bubble deflates
In the dotcom boom and stock market crash, I watched the Nasdaq tech index soar above 5,000 points in March 2000. I also recall its subsequent collapse, crashing by almost four-fifths to nearly 1,100 in October 2002. It then took 15 years for the Nasdaq to get back above 5,000 points.
Some view today’s Nasdaq as bubbly, and a possible trigger for a global stock market crash that pulls down UK shares. The index has soared since 2016, rising 28.2% in 2017, 35.2% in 2019, and 43.6% in Covid-hit 2020. Its only down year was 2018, declining 3.9%. On 16 February, the Nasdaq peaked at 14,175 points. Yesterday, it closed at 13,119, down over 1,050 points (7.5%) in nine days. Though this bubble has let out a little air, US tech stocks remain richly priced. If the Nasdaq declines further, this could be bad news for shareholders worldwide.
2. UK and US bond yields are rising
Some pundits claim there won’t be a stock market crash, because dividend yields look attractive versus bond yields. The problem with arguing that stocks are attractively priced compared to bonds is that the bond market has enjoyed a 40-year bull market. With top-rated bonds offering zero or negative yields, perhaps the bond market is another bubble?
Like US tech stocks, a little air just escaped from the bond bubble. Since 10 February, the 10-year US Treasury yield has surged from 1.13% to 1.61%, its highest level in a year. Likewise, the UK 10-year Gilt yield today hit its highest level since July 2019. If borrowing rates keep rising, this might trigger a stock market crash, as has happened before.
It depends on inflation
Bond yields are creeping up because investors worry about higher inflation. If inflation stays subdued, as it has since 2011, then bond yields should drop back. This would make equities appear more attractive, support share prices, and perhaps ward off a stock market crash. If inflation remains under control, that’s great news for British shareholders. Prices might even climb higher from here. But if inflation rears its ugly head, then things could turn nasty for the UK and US stock markets.
I could be wrong. I don’t want a stock market crash to happen, not least because my portfolio’s 12-month returns have been excellent. But I think the best place to invest today isn’t in richly priced US stocks. When buying prices are so high, this depresses future returns. Happily, the UK stock market is trading at levels relative to the US rarely seen in 50 years. I see the FTSE 100’s big beasts as offering outstanding value for patient investors. That’s why I’m buying cheap UK shares in 2021 and I’ll buy more if a crash comes!