Scanning through headlines, news sites, podcasts, et cetera, I see a common theme out there: bubbles. “Are we in – or approaching – a market bubble?” It’s a question that is coming up more and more in client conversations as well. Below are some thoughts on the topic, which I think might help to provide some perspective.No Time This Time
First off, what is a bubble? It’s a stock market that experiences an excessive rise in prices – one that is fueled more by exuberance and momentum than underlying business fundamentals. It seems that more and more investors and market analysts are on “bubble alert” these days. Why? In my view, the sentiment is: “You’re not going to catch me snoozing this time around. I’m too smart. I’m on bubble alert.”
The most anxious of the bubble-minded may have gone on alert as far back as January 2010, when a popular business news website reported a “surge” of US stocks into bubble territory. Or maybe it was May 2011, when the same website explained why the market “looks like the tech bubble all over again.” A Nobel prize winner warned of a bubble in December 2013, six months before the business section of a leading newspaper suggested it was “time to worry” about one. Headlines began disregarding the hypothetical altogether in April 2018, as when a leading television network advised that an “epic” bubble was “ready to burst.” In December 2019, a leading business magazine deadpanned: “The US stock market is a bubble.” How did all these warnings work out?Schism
Just because a market is up a lot doesn’t mean investors should fall into wild bubble speculation. One reason is because where you stand is a function of where you sit. Based on the chart below, is the S&P 500®
up 13%? Or up 72%? If you take out the Covid-19 drop, it’s up 13% – is this bubble territory? Maybe. Maybe not. Nobody should believe there aren’t pockets of excess out there. What matters is where these pockets might exist.
S&P 500® (12/31/19–1/25/21)
Bitcoin may be a pocket of excess. Shocker, right? I don’t understand how to value it, so I’ll let others who are smarter than me play that game. However, I do know that I can’t use it to buy a Kit Kat at my local convenience store – so what’s the utility in it? Users of bitcoin have to sell it for dollars in order to pay their bills, so what’s the bid/offer price on this thing? Secondly, until you can pay your taxes with it, bitcoin is going to have a regulatory bullseye on its back. And when bitcoin becomes government-regulated, then what happens? For now – and probably for the long run – only dollars are accepted by Uncle Sam, who’s got laws, institutions, and an army to back it up. Bitcoin? Not so much. Until then, it faces an uphill battle, because governments are bigger than bitcoin.
Special Purpose Acquisition Companies (SPACs) could represent another potential pocket of excess. For the uninitiated – or those more accustomed to the traditional initial public offering (IPO) – SPACs are shell corporations designed to take companies public that allow retail investors to make private equity-type purchases like leveraged buyouts. SPAC pricing might be getting a little nutty – it could be a bubble candidate.Perpetual Motion
We can argue over bubbles – and pockets of bubbles – all day long, and many people do. As stated earlier, the bubble watch is probably stronger now than ever before. That in and of itself tells me something – that we aren’t likely to see a dramatic crash in the near term. After all, if nobody was talking about (or searching for) bubbles and everyone was “all in,” it would be a different market story.
What’s important for investors to keep in mind is that stocks go up in bear markets and go down in bull markets. More than likely, we’ll see a correction at some point. Bears will scream that the bubble is bursting, but a correction in the neighborhood of 10% doesn’t make it so. It could just mean the market is taking a momentary break.Taking the Music Back
Remember, stock market valuations are simply opinions – and everyone has an opinion. You have no idea of the price I am willing to pay for an investment or for some specific fundamental. My definition of fair value doesn’t match yours – hence, it’s an opinion. An arbitrary level of price-to-earnings ratio1
isn’t going to necessarily make me (or you) sell.
What about mean reversion? Well, mean reversion isn’t autopilot – it simply assumes that over time, we go back to historical averages. Okay, great. But when? Nobody knows. When it comes to market rotations, there is no automatic trigger or signal. There is a catalyst that triggers a rotation in the other direction which happens to take us back to historical averages. We don’t just sell growth stocks to buy value stocks because growth has outperformed value by 300% over the last 5 years. It doesn’t work like that. There is a catalyst.Remember Tomorrow
Hypothetically speaking, what could cause the current market to recalibrate? As I always say, it’s all about risk appetite. Stock market growth slows when the marginal dollar stops pushing prices higher. No need to overthink this – it’s supply and demand. Risk appetite is what drives the marginal dollar in or out. What drives risk appetite? Two things. First, investors need to feel secure enough in their prospects to establish a capacity to take risk. That is, they need to feel reasonably confident that if a risk they take fails, they can live to fight another day. Secondly, investors need to see others around them making more money than they are.
Unless you think that a full onslaught of bad news related to the Covid-19 virus is coming, I find it tough to not be optimistic about improving prospects as vaccine rollouts accelerate. In my view, the bars below are likely to only get bigger.
Global Doses Administered
Source: Natixis PRCG, Our World in Data. As of 1/25/21.
What’s more, there is evidence that Covid-19 cases are rolling over again in the US and that the holiday surge rush may have started to crest.
Daily New Cases by Census Region (3/12/20–1/25/21)
Source: Natixis PRCG. Covid Tracking Project.
The road from the lab (vaccine development) to immunization (vaccine rollout) was never going to be linear. It’s the trajectory that matters – an improving trend – and that’s what we are seeing. If you want to play the card wherein variant coronavirus strains wreak havoc and put us back somewhere near square one, you can. Importantly, it’s not a 0% probability. Nevertheless, household balance sheets in the US have never been better and it’s hard to buy arguments in support of another economic collapse against this backdrop. In fact, I’ll take the other side of that one and argue that current household balance sheets are a reason to be bullish. It’s firepower for the consumer to spend.
In addition, US personal savings are elevated.
US Personal Savings (12/31/17–11/30/20)
Credit cards are getting paid off – and deleveraging is deflationary.
Credit Card Balances (12/31/18–11/30/20)
Credit card delinquency rates are at historical lows.
Delinquency Rate: Credit Card Loans from All Commercial Banks (1/31/91–9/30/20)
Household debt – the ability of consumers to pay their existing liabilities – has never been better.
Household Debt to Disposable Income (3/31/1980–9/30/2020)
Amid dirt-cheap interest rates, more and more people are buying homes.
US Homeownership Rate (3/31/74–9/30/2020)
Wage and salary workers in the US are making more money.
Median Weekly Real Earnings: Wage and Salary Workers (3/31/79–12/31/20)
It’s worth asking, are these signs that people aren’t feeling secure in their prospects? Historically speaking, why have bubbles popped? It’s usually about the Fed raising interest rates, or when access to credit gets shut off, or when credit simply becomes too expensive. The Fed has made clear that they are not raising for a long time and that they are now targeting an average level of inflation. In fact, Fed Chairman Jerome Powell has said that the Fed is not going to rely on its forecast of inflation as a catalyst to raise interest rates. Instead, the Fed will move in reaction to actual inflation – a huge difference.
Some pundits aren’t believing Powell, arguing that the Fed will blink and hike rates sooner. But this is likely another example of markets wanting to see things that aren’t there. I believe the Fed is telling markets something and saying what they mean, with no hidden agenda.In a Zone
Yes, the market probably has some pockets of excess, but these pockets do not make the entire market. For the time being, it’s worth watching whether or not any of these pockets produce knock-on effects to the broader market. Nonetheless, just because the market is up doesn’t necessarily mean it’s in a bubble. Pundits (and headlines) will continue to call out what they view to be the top of the market, and even a broken clock tells time accurately twice a day. Investors are likely better off keeping an eye on broader risk appetite and keeping an ear to the Fed.
1 The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS). The price-to-earnings ratio is also sometimes known as the price multiple or the earnings multiple.
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