Six big bubbles to avoid and six value opportunities

While it is time in the market, not timing the market, that paves the way for wealth creation, there is also something to be said for making sensible buys and sells.

In many ways, “buy low and sell high” can be seen as the ultimate mantra for investing – buying assets that are lowly valued and have the greatest potential to appreciate. While at the same time avoiding parts of the market that may be overvalued and headed for a correction.

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With that in mind, we asked a range of experts from wealth managers to analysts to name and explain one investment area they view as a potential bubble and one area they believe is a screaming buy.

The results span many areas of the equity markets and include everything from property and gold to bitcoin.

Bubble: Pure play AI

Buy: Unloved UK

Darius McDermott, managing director of FundCalibre, reckons stocks that are pure plays on artificial intelligence (AI) are dangerously overinflated.

He says: “Mounting headwinds such as increased competition and falling demand could mean the AI bubble could deflate in the short term,” he says. “In the long term, AI has the potential to be the next industrial revolution, but we tend to like those companies that are integrating the technology rather than pure-play stocks.”

For investors who want exposure to the large tech companies that dominate the US stock market, Dzmitry Lipski, head of funds research at interactive investor, suggests the Invesco S&P 500 Equal Weight ETF Acc (LSE:SPEQ) for less concentrated exposure.

McDermott’s bargain buy is the unloved UK stock market where quality businesses with attractive growth prospects are trading at historically low valuations.

“Bearing a resemblance to the aftermath of the 2008-09 financial crisis, we believe that, in hindsight, investors will view this period as an ideal entry point to capture significant long-term growth,” he says.

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UK companies appear increasingly attractive when viewed against economic tailwinds such as falling inflation and encouraging GDP data. “Markets are also adapting to the idea of a centrist Labour government ahead of the upcoming election,” McDermott adds.

For exposure to the UK, Lipski likes the iShares Core FTSE 100 ETF GBP Dist (LSE:ISF) and the Artemis Income fund. McDermott particularly likes UK small-caps where even deeper discounts can be found. His fund picks are TM Tellworth UK Smaller Companies and IFSL Marlborough UK Micro Cap Growth.

Bubble: FTSE 100

Buy: Japan

Contrary to popular opinion, having surpassed its February 2023 record closing high, is the FTSE 100 actually overvalued?

“While the UK market remains considerably cheaper than the US, it’s worth considering whether this discount is justified,” says Josef Licsauer, an investment trust research analyst at Kepler Partners.

He adds: “Broadly speaking, UK large-caps exhibit slower growth than US counterparts, often with higher leverage, lower returns on capital and fewer obvious catalysts for future multiple expansion. Consequently, the FTSE 100 might be sitting at fair value or even becoming overvalued.”

UK small and mid-caps are “genuinely undervalued” and “boast greater growth potential”, he says, tipping the BlackRock Smaller Companies Ord (LSE:BRSC) and Schroder UK Mid Cap Ord (LSE:SCP) investment trusts.

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Japan is his “screaming buy”: “Despite reaching a 34-year stock market high, Japan remains cheaper than many developed markets, including the US, Europe and UK. While recent growth stems from governance reform-related improvements, roughly 1,600 listed companies have yet to meet P/B [price/book] and ROE [return on equity] requirements, suggesting untapped potential.”

He cites AVI Japan Opportunity Ord (LSE:AJOT) and CC Japan Income & Growth Ord (LSE:CCJI) as well placed. “While larger, established firms have initially benefited more, the managers argue improvements are trickling down to small and mid-cap companies, creating opportunities in an under-researched part of the market,” adds Licsauer.

Bubble: Bitcoin

Buy: Asia

Bitcoin has been on a tear despite last year’s fraud and money laundering convictions for “crypto king” Sam Bankman-Fried, but Fairview Investing director Ben Yearsley is steering clear.

“I don’t suffer from FOMO [fear of missing out],” he says. “The questions remain the same in my mind. Is there anything backing crypto? What’s the purpose? How can you use it? Who knows apart from crypto bros? In my view, bitcoin has always been a bubble as it has no useful purpose.”

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On the flip side, he has been an Asia bull for a long time. However, he admits: “It hasn’t worked that well. While India has been hitting all-time highs, China has been hitting long-term lows. China has been a definite drag on much of the region, but it does feel it’s near the bottom, even if the property sector woes have yet to be sorted.”

Economically, Asia is on a different trajectory than the developed world. “During Covid-19 many countries didn’t print money, so had a ‘normal’ recession which many are now exiting. Asia is bustling with young, aspirational people who are moving from subsistence to consuming,” says Yearsley.

He favours FSSA Asia Focus as a core holding paired with Fidelity Asia Pacific Opportunities.

Bubble: Unprofitable growth stocks

Buy: Commodities

Ross Garrard, a stockbroker at Ravenscroft, points to the folly of backing unprofitable companies on the promise of tomorrow’s revenues. Take, for example, connected fitness firm and pandemic darling Peloton Interactive Inc (NASDAQ:PTON), which is yet to turn a profit.

“After an IPO at $29, the shares soared to $171 by the depths of lockdown in January 2021,” he says. “Would cyclists ever return to the roads and fitness fanatics to the gym? Unfortunately for Peloton, they did, and today the shares stand at just $4.

“From a peak valuation of $70 billion or 18 times peak sales, today the company is worth just $1.5 billion or 0.6 times 2024 sales – a 98% decline.”

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Commodity miners are firmly in bargain basement territory. They are trading at multi-decade lows despite some of the strongest balance sheets and highest dividend yields around.

“Many investors dismiss mining equities on environmental, social and governance (ESG) grounds but, paradoxically, mining is key to the energy transition,” says Garrard.

He adds: “The result is significant under-investment in new supply at a time when demand is expected to increase dramatically, meaning those with large deposits are sitting on potential ‘gold mines’.”

Ravenscroft’s preferred way to access the space is the BlackRock World Mining Trust Ord (LSE:BRWM), which has exposure to both copper and gold.

Bubble: Gold

Buy: Gold miners

For James Sullivan, head of partnerships at Tyndall Investment Management, there’s a big discrepancy between the price of gold and shares in gold miners.

He says: “Having sailed seamlessly through $2,000 per ounce, the spot price of gold continues to make new highs. What’s most peculiar about this trend is the breakdown of the relationship between gold and real yields.”

Traditionally, gold has fared well amid negative real yields (when inflation is greater than interest rates) as there is no opportunity cost of holding an asset with neither earnings growth nor yield. The reverse also tends to be true, but gold has far from floundered since real yields turned positive in late 2022.

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Meanwhile, higher mining costs, stoked by disruption to global supply chains, have hurt profits and sentiment towards gold mining companies.

“Against a backdrop of falling inflation, the pressure on the spot price of gold will continue to grow,” says Sullivan. “As a leveraged play on the spot price of bullion, gold miners are nicely set up for a reversal of fortunes.

“Inflation is falling away, and we’re witnessing a record high in the spot price of bullion. One can capture this potential renaissance through the BlackRock Gold and General fund,” he suggests.

Bubble: Offices

Buy: Data centre REITs

After a particularly challenging 18 months, it’s safe to say no part of the real estate sector is anywhere near bubble territory but there is one area that Matt Norris, head of real estate securities at Gravis Advisory, thinks could be peaking in another way.

He says: “Certain parts of the office market are doing better than others as rental growth is doing well but investors can’t go into this blindly. The Minimum Energy Efficiency Standards Efficiency Standards, which come into force very soon, means that a high percentage of offices could suddenly become un-leaseable. That would leave a huge dent in prices. While there’s no bubble to burst, values could quickly deflate.”

His value opportunity is data centre real estate investment trusts (REITs), which have sold off as interest rates have risen. The prospect for rate cuts and increased investment bodes well.

“Digital infrastructure is the backbone of the modern economy,” he says. “Savills estimates that Europe’s pipeline of data centres alone will need to more than double by 2025 to meet the growing demand for data storage.”

To capitalise on this, in February, the VT Gravis Digital Infrastructure Income fund invested in Digital Core REIT, a Singapore-listed pure-play data centre strategy.