Gold and stocks both hit new highs—how should this round of "bubble" be traded?

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The Federal Reserve is starting to cut interest rates, global major asset prices are soaring, and the market is entering a bubble period driven by loose monetary policy.

As of September 22, gold had risen 35.4% year-to-date, Bitcoin was up 17.2%, and global stock markets were up 14.3%. High-yield bonds and investment-grade bonds also posted considerable returns of 8.5% and 8.3%, respectively. In sharp contrast, the US dollar index and oil prices fell by 9.3% and 11.4%, respectively.

Bank of America strategist Michael Hartnett points out that tariff cuts, tax cuts, and interest rate cuts together constitute a policy environment of “run-it-hot,” which provides the economy and stock market with an implicit ‘too-big-to-fail’ guarantee. Despite obvious signs of a bubble, it may not have topped out yet. To cope with this round, Hartnett proposes five trading strategies: go long on core bubble assets; construct a ‘barbell’ portfolio by investing in cheap value stocks; short corporate bonds of bubble stocks; short US bonds; and go long on bond volatility while shorting equity volatility.

Goldman Sachs trader Paolo Schiavone adds from a market sentiment perspective that currently the market is permeated by the sentiment that 'money is depreciating, so it is better to spend or invest than to hold it,' further driving funds into risk assets. This mentality forces underperforming fund managers to chase high-risk, high-beta investments in order to catch up with the market benchmark before year-end bonus season.

How much room does this bubble have left?

Although the market is full of bubble discussions, historical data shows that the current rally may still have room. Michael Hartnett analyzed ten stock market bubbles since 1900 and found that the average rise from bottom to peak is 244%, with the peak dynamic P/E ratio averaging as high as 58 times, and the index trading 29% above its 200-day moving average.

Taking the current most representative “Tech Magnificent Seven” as a reference, since the low in March 2023 they have risen 223%, the dynamic P/E is 39, and the share price is 20% above the 200-day moving average. Based on this, Hartnett judges that this bubble “probably has more room to rise.” Historically, the average rise of the 14 US stock bull markets in the last 100 years is 177%, lasting 59 months.

How to Navigate a Bubble Market?

Facing a bubble that may still be inflating, Hartnett proposed a specific set of five trading strategies to help investors navigate the current market:

Go long the bubble itself: Directly invest in the core assets of the bubble. Note that gains during bubble periods tend to be highly concentrated. For example, in the six months before the peak of the 2000 dot-com bubble, the tech sector surged 61%, while all other S&P 500 sectors saw declines.Build a "barbell" portfolio: Invest in bubble assets on one end, and distressed, cheap value stocks on the other. Asset bubbles can stimulate economic growth, boosting these undervalued value sectors. For example, from October 1998 to March 2000, the only market that outperformed Nasdaq was Russia, which had just undergone a debt crisis. Currently, Brazil (P/E 9), the UK (P/E 13), and global energy stocks (P/E 13) can be considered cheap cyclical value stock representatives.Short the corporate bonds of bubble stocks: The credit market typically reflects company fundamentals deterioration earlier than the stock market does. During the dot-com bubble, tech company bond prices fell 13% from October 1998 to March 2000, and their credit spreads started to widen from June 1999.Short US bonds: Historically, among the 14 asset bubbles over the past 300 years, 12 ultimately ended because asset price inflation transmitted to consumer price inflation, prompting policy rates hikes to prick the bubble. During this process, bond yields generally rose.Go long bond volatility, short equity volatility: Stock market rallies usually suppress volatility indices like VIX, but rising rates tend to push up bond market volatility.

Potential Risks and Overseas Opportunities

Despite optimistic sentiment, risks remain. A significant political risk is that Trump’s dissatisfaction rate with inflation issues is as high as 59%. Persistent asset price increases could further pass into consumer goods prices, triggering a second wave of inflation, which would bring huge political pressure ahead of the 2026 midterm elections. As a result, the US government may continue or expand price interventions in “inflation-stirring” industries such as big pharma and big energy. Hartnett also notes that with soaring electricity prices, “large utility companies are becoming the next most vulnerable sector.”

Meanwhile, the sustained weakness of the US dollar is bringing opportunities to international markets. Hartnett points out that “global rebalancing” is the new theme of the second half of the 2020s, and the US dollar bear market benefits international stock markets. A notable signal is that the yen and Japanese stocks have become positively correlated for the first time in 20 years, which is seen as a sign that Japan is entering a real bull market, with a strong yen and rising stock market occurring simultaneously. For investors seeking diversified allocations, this could mean an opportunity window is opening.

Risk Warning and DisclaimerThe market involves risks, and investment should be cautious. This article does not constitute personal investment advice, nor does it take into account the investment objectives, financial situation, or needs of any particular user. Users should consider whether any opinions, views, or conclusions contained in this article fit their particular circumstances. Investing accordingly is at your own risk. ```