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How I’d invest in the 2021 stock market bubble

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US shares are in a stock market bubble, in my opinion. The signs are growing and alarm bells are ringing. U.S. shares are looking expensive on almost every metric. The ratio of the S&P 500’s market capitalisation to US GDP is a long-term valuation indicator, made popular by Warren Buffett. It suggests that the stock market is far more expensive than it was during the technology bubble in 2000.

Another sign of a stock market bubble is euphoria. Widely seen as a state of excitement in the stock market, it’s when many stocks seem to rise regardless of fundamentals or valuation. Stock market euphoria has become more visible in recent months with several initial public offerings surging.

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Food-delivery app DoorDash and accommodation platform Airbnb saw their share prices double on their first day of trading. Several more IPOs are hotly anticipated in 2021, including Robinhood, Bumble, and Coinbase.

Many U.S. technology stocks have seen strong demand over the past decade. Share prices accelerated further in 2020 as the pandemic shifted demand to online platforms at the expense of physical ones such as high street retailers. Ultra-low interest rates and quantitative easing have also been a key factor in supporting US shares.

Investing in a stock market bubble

So, if US shares are in a bubble and relatively overvalued, where is the best place to invest? In my opinion, it’s almost impossible to know when the stock market bubble will burst. It’s entirely possible for US shares to continue rising over the coming months.

Many US technology companies have strong business models with growing earnings and reoccurring cash flows. The fastest-growing companies can expand across geographies quickly and have capital-light balance sheets.

As a UK investor, I would access the strongest and most innovative companies by investing in Scottish Mortgage Investment Trust. Its largest holdings include Tesla, Amazon, Illumina, Tencent, and Nio. The managers are advanced and long term in their thinking. They also have an excellent track record. This investment trust has provided investors with a 350% return over five years.  

When the bubble pops

Although we don’t know when the stock market bubble will pop, I think it’s important to be prepared. When the bubble eventually pops, there are several cheaper markets I’d consider investing in instead.

UK small-cap companies are at the top of my list. Many UK shares have suffered over the past few years from uncertainty surrounding trade deals and the UK relationship with the European Union. With more clarity now, UK shares could start to see increased demand from international investors.

Small-cap companies tend to be under-researched and can offer excellent opportunities for private investors willing to do some research. Currently, I see good value in Best of the Best, Saga, and Volex.

Best of the Best is an online competition company that continues to beat management expectations. Saga targets the over 50s with insurance and travel, where the travel segment could see considerable growth post-pandemic. Volex is a high-quality cable manufacturer with fast-growing markets including electric vehicles and data centres. I’d consider all three for my portfolio.

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Harshil Patel owns shares in Scottish Mortgage Investment Trust, Amazon, Tesla, Best of the Best, Saga, and Volex. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Amazon, Illumina, and Tesla and recommends the following options: long January 2022 $1920 calls on Amazon and short January 2022 $1940 calls on Amazon. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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