Bubbles always burst, are we in one?
04/18/2022
It goes without saying that bubbles are prone to bursting and those experienced in the economy are no exception. The difficulty, however, lies in identifying economic bubbles and positioning one’s investments so as not to get burned when the bubble pops. Thankfully, previous clues left behind from previous bubbles have been identified by author and Yale Professor Vikram Mansharamani whose 2010 book “Boombustology – Spotting Financial Bubbles before They Burst” points out several common characteristics he’s compiled from those earlier bubbles. Among these characteristics are easy access to credit, cheap money through low interest rates, conspicuous consumption and belief that this time it’s different, supply and demand manipulation, a willingness to pay more without regard to actual value, and celebrities and influencers touting some new idea, along with others. Combining these identifiers with my own observations of what’s going on today, I’ll attempt to show areas which I suggest indicate we are presently experiencing an economic bubble. Before pointing them out, let’s see how we got here in the first place.
Our present economic cycle began after the collapse of the housing market bubble which led to the Great Recession and a subsequent sell-off of the U.S. stock market. When it was all said and done, the result was an S&P 500 decline of -37% at the end of 2008. In its effort to kick-start the economy the U.S. government embarked on an extensive period of low interest rates. Next, over a decade into these lower rates, it indiscriminately pushed stimulus money into the system by mailing checks to every citizen and most any business with a claim, and then initiated a protracted period of providing unemployment dollars to displaced workers as the country progressed through the pandemic caused shutdown. Today, we are living with the results of those government actions which include economic activity of epic proportions and which recently have led to the beginning of a series of interest rate hikes in 2022. Just how overheated might the economy be is perhaps subject to interpretation. What follows is a list of indicators which I believe show that we are far into an economic bubble and it may be about to pop.
Perhaps the most convincing indicator is today’s housing market. Existing home’s which previously might be on the market for several weeks or longer are selling in a single day with bids often coming in at well over the asking price. Back in the fall of 2020, my wife and I experienced the phenomenon when after living in our home for nearly 26 years we decided to look for a new residence. More often than not, the houses we looked at would sell that very day disallowing us the opportunity to think things over and resulting in a frustrating experience. Later, when we were selling our own house, we had eight appointments quickly scheduled for the opening day which led to two bids above our asking price and a sale to the second bidder when the first fell through. Regarding the prices which people are willing to pay for existing houses, the average national increase for 2021 alone was 18.8%. For this year, they are expected to increase another 16.4%.
Next, there’s the automobile chip shortage which resulted in backorders for certain automobiles which need the chip for their completion. While under normal circumstances, some eager buyers would grow frustrated and move on to other vehicles there’s been such a frenzy to obtain these vehicles consumers seem to be willing to pay just about any price. The fervor has reached such proportions that car dealerships are calling present owners of the hottest vehicles and offering them thousands of dollars above the retail price previously paid. Of note is these cars are then resold at such prices they absorb not only the retail price the dealer paid the previous owner but the commission the dealer has to earn to make the transaction worth his while. Noteworthy of mentioning is the fact that automobiles, under normal circumstances, are depreciating assets meaning they decline in value with each passing year.
Another indicator is the advent of free stock trading, low or no account minimums, and the ability to purchase partial shares for those who can’t afford the full purchase price of a single share of certain companies which has led to droves of amateur investors joining the fray. The rising presence of amateurs in an activity is often indicative of a bubble. Known as the “Reddit crowd” this group of mostly younger investors often join together to drive up the cost of their favorite companies regardless of the underlying value. On occasion the crowd’s activity has served even to disrupt normal stock market activities when it comes to buying and selling. Today there’s even a term for a company which has grown popular with the crowd through social media. It’s called a “meme stock”. Meme stock prices are mostly driven by their popularity among inexperienced investors with little regard to their actual worth.
Then, there’s crypto currency. Buy-in for devotees has resulted in a price per Bitcoin increase from a $911 close on January 2, 2017 to $39,857.62 at the end of the day on April 11, 2022. While that rise in value has been nothing short of fantasy, it should be noted that Bitcoin had previously reached a valuation of $65,466.84 at the end of the day on November 8, 2021. Note: I’m not saying crypto currency isn’t here to stay, but a 4,375x increase in just over 5 years and 3 months appears suspiciously like a bubble.
Other possible indicators include two other phenomena the SPAC and, most recently the NFT. According to Investopedia, a SPAC or “Special Purpose Acquisition Company, is a company that has no commercial operations and is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring or merging with an existing company”. While in 2021 there were 613 SPAC IPOs, only 59 SPACs came to market in 2019 for an increase of over 10 xs in just two years. Previously unknown to the common investor, these short-term entities are now available to the general public. As in other instances where something new has been introduced folks have flocked to SPACs in an effort to get in on the ground floor. Of note, however, is that SPACs are also known as “blank check companies”. The reason for this is that investors aren’t given notice before investing of just what the company will be investing in. Investopedia goes on to say “an investor in a SPAC IPO is making a leap of faith that its promoters will be successful in acquiring or merging with a suitable target company in the future”, and “that retail (amateur) investors run the risk of being saddled with an investment that could be massively overhyped or occasionally fraudulent”.
For the NFT or, non-fungible token I offer Wikipedia’s description verbatim: “The non-fungible token (NFT) is a non-interchangeable unit of data stored on a blockchain, a form of digital ledger, that can be sold and traded. Types of NFT data units may be associated with digital files such as photos, videos, and audio”. Meanwhile, …”NFT ledgers claim to provide a public certificate of authenticity or proof of ownership, but the legal rights conveyed by an NFT can be uncertain. NFTs do not restrict the sharing or copying of the underlying digital files, do not necessarily convey the copyright of the digital files, and do not prevent the creation of NFTs with identical associated files.” “NFTs…have drawn increasing criticism for the energy cost and carbon footprint associated with validating blockchain transactions as well as their frequent use in art scams. The NFT market has been compared to a Ponzi scheme”.
So much speculation, in this author’s opinion, points toward trouble. That’s because, when the credit fueling the previous bubbles began to dry up it tended to slow speculation. In every instance a decline in speculation resulted in earlier entrants being financially squeezed and unable to unload their speculative holdings. Consequently, this caused them to grow increasingly willing to sell at lower and lower prices until eventually there was a fire-sale which caused prices to fall ever farther. Finally, when the bubble burst no one wanted to buy the speculative product. I was only after much time had passed and all of the fluff had been shaken out, that things gradually returned to normal and the cycle began once more.
While forecasting when an economic bubble is going to burst is folly recognizing the signs of exaggerated speculation in different areas of the economy is quite another matter. With irrational signs everywhere, investing in today’s environment calls for prudent investing. The collective stock market remains at an extremely high valuation despite the recent volatility and, at some point stock prices will inevitably fall in response to the slowing economy. My response to stock market investing whether the market is up, down or about to fall is the same. When it comes to stock investing portfolios should be positioned to accommodate any economic condition. At Long Run Financial, Ltd., my investment portfolios are designed to do just that. That’s because I build portfolios with a market-neutral approach regardless of which direction the stock market appears to be headed.
I call it Sector Neutral Income Portfolio Investing or, SNIPI™ for short. To learn more about SNIPI™ and how it can protect your assets when the market pulls back go to LongRunFinancial.com. Discover what the SNIPI™ investor knows, while you can’t predict what’s going to happen, SNIPI™s market-neutral stance provides growth in the good times and protection when the bubble bursts.
Sincerely,
Dennis Gravitt AFC®, CFP®, President
President, Long Run Financial, Ltd.