This hedge fund says the trouble with bubbles is that they're not predictive

Zweig-DiMenna hedge fund argues that high market valuations are not predictive of short-term performance, despite historical peaks often coinciding with market downturns. They suggest diversification into bonds, commodities, and international equities. Current high valuations, influenced by tech sector weightings, don't signal immediate market shifts. Their holdings include AppLovin, Amazon, and Broadcom, with Amazon being the cheapest based on future earnings.

By Jules Rimmer Analysts observe that previous examples of elevated market valuations have often been followed by strong equity returns. Peak valuations don't automatically guarantee market peaks. The November newsletter of one of the more successful hedge funds of recent times makes it clear that while U.S. valuations are indisputably stretched, it's not at all useful for market timing. Chief investment officer Michael Schaus and portfolio manager Matthew Finkelstein of Zweig-DiMenna, a hedge fund manager of four decades' standing, are clearly agnostic about valuations because their own proprietary analytical model reached the 90th percentile in January 2024. Since then the S&P 500 SPX is up 40%. Right now, the reading on that model stands at 92.5 but this doesn't necessarily signal a turning point in market direction either, they say. What the report's authors do acknowledge, though, is that "peak valuations are negative for equity returns going forwards and... with hindsight, it is true market peaks generally coincide with peak valuations." Right now, Zweig-DiMenna accepts U.S. equity valuations are high by most measures. The S&P 500's price-to-earnings ratio of around 28 times has only been higher in 2021 and 2000 and in both instances performance was extremely poor during the following twelve months. Another frequently used metric is the Shiller cyclically-adjusted price-earnings ratio that, at 40, also stands at a 25-year high. The Shiller CAPE ratio hit 40 in 1998 also but still managed to deliver 22% over the next 15 months. P-to-E ratios are high but what this means for the market right now is unclear. The bulletin also presents an interesting argument that the uncertainty generated by the government shutdown and its tariff policies may prolong the current business cycle by retarding "the overheating and irrational exuberance that often leads to recessions." Zweig-DiMenna's analysts argue that the valuation picture is more nuanced, however. Historical comparisons are complicated by the heavy index weightings at present of high price-to-earnings sectors like technology, compared with previous index-leading sectors like energy that typically command lower ratios. The point made by Finkelstein and Schaus is that valuation is not predictive for short-term performance, but nonetheless it does make a good argument for diversification into bonds, commodities and cheaper international equity markets. Zweig-DiMenna's 13-F filing, showing holdings through the third quarter, reflects that the firm does not believe the music is about to stop, with top holdings including AppLovin (APP), Amazon.com (AMZN) and Broadcom (AVGO). Amazon is the cheapest of those, at a price-to-earnings ratio of 33 times 2025 earnings, according to FactSet. -Jules Rimmer This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal. (END) Dow Jones Newswires 11-18-25 0526ET