How big is the US stock market bubble? UBS provides seven key indicators to watch.

Author: Ye Huiwen Source: Wall Street Insights

As U.S. stock valuations remain high, discussions about whether the market has entered bubble territory are intensifying. Despite strong corporate earnings, Wall Street executives have begun warning of potential pullback risks.

According to ChaseWind Trading, UBS’s latest report presents a framework with seven indicators, concluding that the current market is in the early stages of a potential bubble and has not yet reached a dangerous peak.

They note that the price-to-earnings ratios of tech stocks are close to normal relative to the overall market, with better earnings revisions and growth prospects, and capital expenditure cycles still in early stages. Most importantly, there are no signs of excesses typically seen at historical bubble peaks.

UBS summarizes that if there is a bubble, it might be reflected in the high profit margins of tech giants. As industry capital intensity increases and competition intensifies, these high margins could face downward pressure in the future. But for now, the market is still far from a truly dangerous point.

Seven Preconditions for Bubble Formation

UBS equity strategist Andrew Garthwaite and his team outline seven conditions typically needed for a market bubble to form. They believe that if the Federal Reserve follows the rate-cutting path UBS predicts, all seven conditions will be triggered.

• Buy-the-dip mentality: Over the past decade, stocks have outperformed bonds by an annualized 14%, well above the 5% threshold needed to foster such a mindset.
• “This time is different” narrative: The rise of generative AI (Gen AI) provides a powerful new technological narrative.
• Generation gap in memory: It’s been about 25 years since the last tech bubble (1998), making new investors more susceptible to believing “this time is different.”
• Overall profit pressure: In the U.S., excluding the top 10 companies by market cap, the remaining firms’ 12-month forward EPS growth is near zero, similar to the profit environment during the dot-com bubble.
• High concentration: Currently, the concentration of market value and revenue among top companies is at historic highs.
• Retail investor enthusiasm: Retail trading activity has surged in the U.S., India, South Korea, and other regions.
• Loose monetary environment: Financial conditions are already accommodative, and if the Fed cuts rates as expected, monetary easing will intensify.

Three Major Signals of a Market Top

While the conditions for a bubble are gradually aligning, UBS believes the market is still some distance from a true peak. The report analyzes key signals indicating a market top from valuation, long-term catalysts, and short-term catalysts.

1. Explicit overvaluation: Historically, bubble peaks are associated with extreme valuations. For example, in past bubbles, at least 30% of market cap companies had P/E ratios between 45 and 73, whereas currently, the “Big Seven” tech giants (Mag 6) have a forward P/E of 35. Additionally, the equity risk premium (ERP) has not fallen to the extreme lows of around 1% seen in 2000 or 1929.

2. Long-term cycle top catalysts: Several long-term indicators do not show signs of a peak. First, investment in information and communication technology (ICT) as a percentage of GDP remains well below 2000 levels, indicating no signs of overinvestment.

Second, leverage among tech giants is much healthier than during the dot-com bubble. Moreover, market breadth has not deteriorated as severely as in 1999, when the Nasdaq nearly doubled but the number of declining stocks was almost twice the number of advancing stocks.

3. Short-term cycle top catalysts: On the short-term, there are no urgent signals of a top. For instance, extreme M&A activity like Vodafone/Mannesmann or AOL/Time Warner in 2000 has not reemerged. Additionally, the Fed’s policy stance is far from tightening enough to trigger a crash. Historical experience suggests that markets tend to top when interest rates approach the nominal GDP growth rate (projected at 5.2% in 2026).

Lessons from the Post-TMT Bubble Era

UBS reviews lessons from the 2000 tech, media, and telecom (TMT) bubble burst to offer investors some insights. First, after a bubble bursts, value may flow into non-bubble sectors, with non-TMT stocks initially rallying. Second, markets may exhibit “echo effects” or double-top formations. Most importantly, “concepts are correct but prices are wrong”: stocks like Microsoft, Amazon, and Apple plunged 65% to 94% from their peaks, taking 5 to 17 years to recover.

The report emphasizes that the ultimate winners in the value chain may not be infrastructure builders but those who leverage new technologies to create disruptive applications or key software solutions.