Are we in a bubble?

Are we currently in a bubble? Will the bubble expand before it implodes? These are increasingly common questions among market participants.

Our view is that certain segments of the equity market are exhibiting clear signs of bubble-like behaviour. In particular, US small-cap stocks have become especially frothy. Within high-profile thematics like drones, defence, and rare earths, valuations for many companies are now pricing in near-perfect outcomes. History suggests not all of them will succeed. This dynamic is reminiscent of the 2021–22 bubble, though with some notable differences.

The prior bubble cycle centred around meme stocks and cryptocurrencies. Today, speculative activity has shifted toward small caps, often driven by thematic enthusiasm rather than grounded forecasts. The speculative focus continues to evolve, but the underlying behaviour remains similar.

That said, we do not believe the overall market is in a bubble. Valuations for major indices and Big Tech are elevated relative to long-term averages, but not alarmingly so. Even within the AI space, despite rapid price appreciation, earnings growth has continued to track upwards. In our view, the aggregate of AI-related equities, while not cheap, cannot yet be classified as a bubble.

We believe there’s a reasonable likelihood that the current bubble expands further before it unwinds. There remains a substantial pool of savings in the system, which continues to grow. For example, even after tariffs were introduced in Q2 2025, US consumers not only maintained their elevated levels of spending but also increased their savings, a clear sign of underlying resilience.

A key difference between today and previous cycles lies in who is doing the spending. The ongoing surge in AI infrastructure investment is being led by Big Tech, and crucially, it is being funded through free cash flow rather than equity issuance or excessive leverage. Unlike the dot-com bubble in 2000, this capex is proportionate to actual AI usage growth. This isn't speculative overbuild, it’s an infrastructure cycle tied to observable demand.

At a broader level, the financial market bubble is beginning to mirror what we might call a Trump Bubble – a feedback loop between political narrative and market expectations. Much of Trump’s political appeal rests on a promise to transform the lives of those left behind by globalisation. Central to that promise are a series of new trade deals and the reshoring of industrial capacity.

However, job creation remains weak, partially constrained by restrictive immigration policies, and Trump’s second-term fiscal agenda has not been expansionary. That leaves him with two remaining levers: AI-fuelled economic optimism and rapidly rising asset prices. These forces are now doing the heavy lifting in maintaining the appearance of economic strength.

In that sense, the market’s current exuberance is not only tolerated by the administration – it’s essential. The AI boom and the stock market rally have become political imperatives, sustaining the broader Trump economic narrative.

As stock prices rise rapidly and the bubble inflates, the incentive to speculate draws more capital from the growing pool of household savings into equity markets. We believe we are still early in this process. Each year, the stock of available savings expands, and with it, the fuel for continued market momentum. The psychology of the bubble – anchored by "buy the dip" behaviour – is becoming increasingly entrenched. With time, investors begin to feel invincible. To us, this environment feels reminiscent of 1998–99.

Bubbles typically burst for one of several reasons. A shift in investor psychology becomes harder to trigger as the euphoria builds. It often takes a significant event to challenge prevailing optimism – historically, either a recession or a sharp tightening cycle from the Federal Reserve, like in 2022. Another common catalyst is when valuations become so stretched that they can no longer be supported by the available savings or access to debt.

A potential candidate for disruption this time could be a re-escalation of the US–China trade war, particularly if it impacts critical supply chains or corporate earnings. While we’re monitoring this risk closely, our base case remains that a fragile equilibrium between both sides will likely prevent a major flare-up.

Absent a clear catalyst, however, we believe the current market dynamics will continue to be underpinned by a structural imbalance between asset demand and supply. We are far from the point where savings or income growth are insufficient to sustain today’s asset prices.

Against this backdrop, our approach is to invest in assets that are not yet part of the bubble, but that (i) remain fundamentally cheap and (ii) have the potential to re-rate dramatically if sentiment shifts.