With Global Indices Overbought, Is the Bubble About to Pop?

After the financial crisis of 2008/9, the financial markets around the world have seen tremendous growth. Consider the 5-year chart below of the major global indices.

As seen, the NASDAQ has led the way, gaining by more than 150% while the FTSI 100 has been the laggard, gaining by just 18%. This is attributed to the risks posed by Brexit on the UK economy.

At the same time, the CBOE Volatility index, which measures the volatility in the financial markets, has stayed at significant lows as shown below.

The surge in the global stocks markets is associated with the central banks decisions. After the crisis, the global central bankers moved to rescue the economy by introducing low interest rates. They also started a large scale asset purchase in what is known as the quantitative easing. In other words, they printed billions of dollars to buy treasuries and mortgage backed securities.

So far, only the Fed has moved to end the stimulus package. Other banks have issued forward guidance on when they will end the packages.

Another reason why stocks have done well is because of corporate earnings. In the past five years, corporate earnings in the United States and in around the world have risen significantly. For example, in 2010, a company like Facebook was making a few billion dollars in annual revenues. Last year, the company brought almost $30 billion in revenues. At that time, a company like Snapchat never existed. Last year, the company made billions of dollars.

Therefore, corporate earnings and easy money have led the stocks market to grow. Another reason which is less talked about is crude oil. As shown below, the price of crude oil has lost about 32% in the past 5 years. This year, the major indices have continued to break records every day.

For traders, the daily movements of stocks, currencies don’t matter. This is because, they can always buy and sell financial instruments and exit within a short period.

For long-term investors however, these are difficult times because of the difficulty in finding reasonably-valued companies. Some of the most loved companies like Amazon, Tesla, and NVIDIA are overvalued based on multiple valuation measures like ratio analysis. For example, Tesla, which makes electric cars, is currently valued at more than $50 billion, which is close to that of General Motors, which is selling more electric vehicles than Tesla.

From a technical perspective, all the major indices are in the extreme areas of being overbought. Consider the chart of the Dow and NASDAQ below.

Dow Jones Industrial Average

NASDAQ Composite

Hang Seng

The overbought situation is seen among all the major indices.

The challenge at this time is that Central Banks are moving to Quantitative Tightening, which is the opposite of easing. By tightening, they will normalize interest rates and end purchases. Still, the interest rates are at historical lows. In the United States, the administration has brought corporate taxes to significant lows.

For investors, the fear is that markets are in a bubble, which could pop at any time. If it pops, as it happens during periods of tightening, the central banks might not have any options to save the financial market. Historically, when there is a financial crisis, central banks move to lower interest rates while policy makers move to lower corporate taxes. They do all this to stimulate the economy. Now, with interest so low, and with the tax plan passed, it would be difficult for the policy makers to contain a recession if the bubble pops.

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