Bubble To Cause A Market Crash?

Dear Rich Lifer,

The recent wild week for the stock market seems to display what many experts have been observing over the past year — much of the market is in a bubble.

From January 25 through January 29, individual investors sent shares of Gamestop Corp up 500%. Shares in Gamestop have since fallen and were recently down 28%.

However, shares of other “unprofitable” companies such as AMC Entertainment Holdings and Blackberry are rising at a never-before-seen pace.

Meanwhile, options activity is surging, bitcoin prices are approaching record highs and businesses are rushing to sell stocks through initial public offerings (IPOs), listings of blank-check companies and follow-on share sales.

Valuations appear stretched as they hover near very similar levels to 2000. However, high valuations don’t necessarily mean the end of a rally. History has shown us multiple times that the markets can endure longer climbs than experts thought possible. Take, for example, the dot com boom in the late 90s or the famous rise in Japanese stocks in the 80s.

Despite the meteoric rise in these niche pockets of the market, the broader market has been declining. On Friday, January 29, stocks fell sharply in their worst week since October. Meanwhile, on the same day, GameStop rose 68% and AMC jumped 54%.

This has led some to believe that the bubble-like behavior is contained to a handful of stocks and won’t actually impact the market as a whole.

Other arguments against a market wide bubble have to do with interest rates. Because interest rates are at rock-bottom, investors are able to put their money into riskier, higher-yielding assets.

However, others say that move toward more extreme and risky investments could prove to be a disaster.

“You Should Be Very Worried”

Richard Fisher, the former president of the Dallas Federal Reserve, seems to be of this mindset commenting, “I think we’ve had a bubble for some time. This is just icing on the cake. When things get out of control like this, it is a sign that you should be very worried.”

And yet, bullishness on stocks among money managers is at a three-year high, according to a Bank of America survey of 194 money managers overseeing $561 billion in assets. Conversely, the average share of cash in portfolios — a traditional safeguard against volatile markets — is at the lowest levels since May 2013.

Now, investors are tasked with attempting to identify what may cause bubbles among individual stocks to pop and whether smaller bursts could spread to the larger market. This task is proving to be quite difficult.

Jeremy Grantham, co-founder of Boston money manager Grantham, Mayo, Van Otterloo & Co., predicted the market crashes of 2000 and 2008 and isn’t optimistic about what he’s currently seeing with the markets. When he looks at how the markets are trending today he comments, “You know, this one has checked off all the boxes from a history book.”

However, he does admit that identifying the timing for a market top is more difficult than ever due to “the help of new trading platforms and the internet.”

But, Mr. Grantham is not the only expert with worries. Nearly 90% of almost 627 market professionals think some financial markets are in a bubble, according to a recent Deutsche Bank survey.

Even your casual day trader has picked up on the market trends, with Google searches for the term “stock market bubble” reaching an all-time high in January.

Jerry Braakman, chief investment officer of First American Trust, says, “the market has not been correlated to the macro picture” and advises shifting money away from overvalued U.S. stocks.

Jarring But Not Surprising

As much as the last few weeks may have been particularly jarring, analysts and investors are not particularly surprised about the speculative stock market activity.

The Federal Reserve has been incredibly accommodating, there have been low interest rates, and there is now an increase in optimism about the coronavirus vaccine and the economy. All these trends have encouraged the buying we have been seeing over the past months.

Additionally, many Americans have been fortunate enough to build up their savings over the past year, which has allowed them to begin trading in the stock market as individual investors.

And as we have clearly seen in the past week especially, individual investors have the ability to make waves in the markets.

Individual investors drove records this past Wednesday, with 24.5 billion shares and 57.1 million options contracts changing hands in a single day, according to Rich Repetto, a managing director at Piper Sandler & Co.

And instead of shying away from the frenzied markets, big companies are actually itching to get on the action. Companies have raised $13.4 billion through 24 IPOs so far this year, a 300% jump in listings from the same period last year, according to Renaissance Capital data.

Blank-check companies are also flooding the market, with 91 gathering about $25 billion, nearly a third of the value raised throughout all of last year, according to SPACinsider.com.

Money managers also seem unphased by the bubbles forming in parts of the market. Samantha McLemore, a portfolio manager at Miller Value Partners, says, “These stocks don’t make up the bulk of the stock market. There are so many areas of the market that we’re finding attractively valued.”

Goldman Sachs reports that the increase in unprofitable stocks — like GameStop and AMC — poses little risk for contamination of the larger market because such companies only account for 5% of the overall market.

Investors are clearly not ready to pull back, and only time will tell how this strategy will ultimately play out.

Mr. Braakman of First American Trust warns, “We’ve seen it in the past—if you think you have a bubble and sell too soon, that can be a very costly trade.”

It’s anyone’s guess what will come next. We are now seeing silver prices rallying, with most actively traded silver futures jumping more than 10% to $29.63 a troy ounce on Monday, their highest level since February 2013.

The rally started late last week after users on Reddit’s WallStreetBets forum posted about executing a short squeeze similar to ones credited with fueling recent gains in other stocks popular on the internet (GameStop, AMC, BlackBerry, etc…).

We will keep our eye on this notoriously volatile precious metal.

To a Richer Life,

The Rich Life Roadmap Team

You May Also Be Interested In: