The stock market would have to drop as much as 40% to be fairly valued, one respected adviser explains.
Part of the thesis is rooted in Brad McMillan's belief that the lofty levels of tech stocks seem reminiscent of the dot-com bubble.
"The market probably would have to drop somewhere between 30 and 40 percent to get to fair value, based on historical standards," McMillan, chief investment officer at Massachusetts-based Commonwealth Financial Network, told CNBC.
"Take as much risk as you want now. But you should be aware that at some point the market is going to pull back," he said.
"Right now, a recession is a good ways away. And that's the engine for bear markets."
But McMillan warns that the lofty levels of the so-called FANG stocks — Facebook, Amazon, Netflix and Google-parent Alphabet — seem reminiscent of the dot-com bubble in the late 1990s.
"I've been saying for about the past year, this year looks a lot like 1999 to me," McMillan told "Squawk Box." "If you look at the underlying economics [and] if look at the stock market, the similarities are remarkable."
McMillan isn't alone in fretting about lofty market valuations.
The number of investors saying equity markets are overvalued rose to a record high of 46 percent in August, a recent Bank of America Merrill Lynch’s monthly fund manager poll showed.
The survey, which polled 202 asset managers with $587 billion under management, was carried out between August 4-10 and showed cash levels at a stubbornly high 4.9 percent, whilst the allocation to equities fell to a net 36 percent overweight, Reuters reported.
BAML noted an “ominous inflection point” in the profit expectations indicator, with only a net 33 percent of investors saying corporate profits would improve over the next 12 months. This was down 25 percentage points from January to the lowest level since November 2015.
The bank suggested this was a warning sign for equities over bonds, high yield over investment grade and cyclical sectors over defensive ones. “Further deterioration is likely to cause risk-off trades,” said Michael Hartnett, chief investment strategist.
Expectations for faster global growth also fell to 35 percent in August, down from 62 percent in January, and the outlook for corporate operating margins stalled.
However, the percentage of investors expecting a ‘Goldilocks’ scenario of above-trend growth and below-trend inflation rose 6 percentage points to 42 percent, a record high.
However, others only see the good times rolling into the future, Bloomberg reported.
“We have solid global growth and some of the easiest financial conditions in history,” Andrew Sheets, Morgan Stanley’s chief cross-asset strategist, wrote in a client note. “Hooray.”
Meanwhile, China’s producer prices surged 6.3 percent in August from a year earlier, ahead of expectations by a margin comfortable enough to drive speculation that the world’s second-largest economy may spark momentum across developed and emerging markets alike.
An uptick in China’s producer prices often spurs better-than-expected economic data in Europe and the U.S., potentially adding fresh impetus to the global rally.
“China reflationary impact has been one of the keys ensuring globally co-ordinated recovery through 2016/17,” Macquarie Group Ltd.’s Viktor Shvets and Chetan Seth note.
The signs of accelerating global growth come as liquidity conditions have loosened thanks to the dollar’s retreat, lower Treasury yields and the relative resilience of credit and equity markets.
Investors in the $14.1 trillion Treasuries market aren’t getting compensation for time risk, forcing money managers to pour more cash into risky assets. The extra compensation to own 10-year U.S. Treasuries instead of shorter-maturity obligations, for example, a spread known as the term premium, has fallen to October lows.
Loose liquidity conditions are giving ammunition to credit bulls from the U.S. to emerging markets, with Tajikistan the latest frontier issuer to join the junk-bond party. Citigroup Inc. strategists on Monday said investors should boost their exposure to investment-grade corporate debt by selling bond insurance, citing dovish projections for the U.S. interest-rate cycle.
“It becomes ‘the greater fool’ game with investors counting on the U.S. yields falling and thus search for yield becoming ever more frantic,” conclude Macquarie’s Shvets and Seth.
(Newsmax wires services contributed to this report).
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