Ray Dalio’s bubble indicator reveals US stocks aren’t dangerously high – but 50 of the top 1,000 companies are in ‘extreme bubbles’

• Ray Dalio’s bubble indicator suggests that the US stock market is not dangerously high.
• However, he found that 5% of the top 1,000 US companies were in “extreme bubbles”.
• He also identified the foam in stock prices, new buyers, the uptrend and the use of leverage.
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Ray Dalio’s bubble indicator suggests that US stocks are not trading at unsustainable prices and could climb.

The billionaire co-head of the world’s largest hedge fund, Bridgewater Associates, said in a research note this month that its market gauge sits at the 77th percentile for the entire U.S. stock market. His readings for bubbles in the 1920s and 1990s are in the 100th percentile.

However, Dalio noted that 5% of the top 1,000 US companies – including several players in emerging technologies – are currently in “extreme bubbles.” Still, that’s less than half the percentage at the height of the dot-com boom.

Dalio’s bubble indicator combines six measures of the stock market. They are:

• What is the price level compared to traditional measures?
• Are prices discounting unsustainable conditions?
• How many new buyers have entered the market?
• How generally bullish is sentiment?
• Are the purchases funded by high leverage?
• Have buyers made unusually long forward purchases to speculate or hedge against future price gains?

The Bridgewater chief’s gauge shows that US stocks are valued in the 82nd percentile on traditional metrics, and the 77th percentile in terms of the earnings growth needed to outperform bonds.

Its reading for first-time buyers is in the 95th percentile, largely due to the boom in retail investment. The uptrend is at the 85th percentile, in part due to the “unusually warm” IPO market, which has been supercharged by a flood of special purpose acquisition companies or “SPACs”.

The Dalio stallion revealed that leveraged buying, fueled by day traders who are capturing record volumes of call options on single stocks, is in the 79th percentile.

In contrast, forward purchases are in the 15th percentile – down from the 100th percentile in the late 1990s – as the pandemic has depressed business investment and weighed on the number of mergers and acquisitions.

The billionaire hedge fund indicator signals some foam in stocks. However, he is positively bullish on Warren Buffett’s preferred gauge and recent warning from “The Big Short” investor Michael Burry that the stock market is “dancing on the edge of the knife.”