Market Perspectives

Are We In a Bubble? Where—and How—to Find Value in Today's Market (June 2013)

by Russ Koesterich, Managing Director
iShares Global Chief Investment Strategist

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Are we in a bubble? That’s the question many investors are asking with equities up 25% since their June 2012 bottom. If it’s not a bubble, are the high returns sustainable? And what methods best determine if a market is cheap? This paper takes a look at these questions. Our findings:

No, it’s not a bubble. Despite the rally, most traditional valuation metrics still suggest that stocks appear reasonably priced on an absolute basis and cheap compared to the alternatives, particularly cash and bonds.

But be careful, reasonable valuations, particularly in the United States, are partly a function of record high profit margins. These are likely to revert back to their longterm average. Equities are still likely to outperform bonds—which are unusually expensive thanks to central bank buying—but are unlikely to produce the consistent double-digit returns that have historically been the result of lower valuations.

Looking for value—our approach. When evaluating the market, we look beyond simple value metrics and take into account the macroeconomic fundamentals that have historically driven value. That methodology reveals:

- What’s expensive: areas where investors are paying too much for either safety or growth. Some examples of the former are the United States and Switzerland, while the latter includes smaller emerging markets, such as the Philippines, which are vulnerable to any deceleration in growth.

- Where we find bargains. Primarily in the larger emerging markets, Asia, and parts of Europe where investors have been scared away by the perceived risks. While we would not minimize those risks, we believe that the headwinds are more than discounted into the price. For investors able to accept the volatility, these areas look like the best long-term values.

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