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From a general theory of markets perspective, you can’t be in a bubble if people are asking if we are in a bubble. People only ask if we are in a bubble when they are afraid to keep capital in their portfolios or commit new capital to their investments. This means either:
- They have assets that have gone up substantially in value, which they are considering selling (some of them will sell), or
- They have the capacity to commit capital to their investments – and they aren’t doing it.
Bubbles form because we buy WITHOUT considering valuation. Bubbles exist when we aren’t worried about bubbles. Those asking questions about bubbles are, by definition, worried about valuation and the potential for bubbles. It can’t be a bubble when people are afraid to invest. Perhaps the best simple definition of a bubble is the following:
We know it’s a bubble when we have collectively thrown caution to the wind and become more concerned about missing out on the next leg of returns than we are about losing the assets we have already accumulated.
We’ve been getting the “are we in a bubble” question since 2014. We weren’t in a bubble then and, while things certainly are not “cheap,” there are certainly specific investments that are looking frothier these days.
How do we spot a bubble?
I am a fan of William Bernstein’s four-part list of bubble markers because it delves into the culture and changes in human relationships that occur as a bubble inflates. Do you see these four today?
First, financial speculation becomes part of everyday conversation. The frothy investment is on the front page of every paper, is part of every broadcast, and is a question for every financial podcast guest. Your uncle, who has never spoken to you about an investment of any kind, casually brings it up in conversation. Consider the “new paradigm” talk during the dot.com boom of the late 90s and the steady drumbeat of real estate headlines in 2005 and 2006. Then, ruminate on the recent fascination with the GameStock trades, Tesla, SPACs, NFTs, and bitcoin.
Second, look at the career changes as people leave perfectly good day jobs to chase the easy-money dream. In the late 90s this took the form of day-trading internet stocks. In the early 2000s non-working spouses all got their real estate sales licenses in order to start flipping houses. Now, ponder today’s TSLA, GME, SPAC, and crypto traders. They may not have quit their day jobs, but many are margining their federal stimulus checks to buy and sell stocks while working from home.
Third, a cult begins to form around the believers. The cult becomes the “us” in an us vs. “them” battle for the truth. Beware any who question the run or call it a “bubble,” for all those who disagree will be drawn and quartered in media. They will be socially spurned.
In the late 90s, if you pointed to the hundreds of freshly IPO’d companies without any earnings -or even paths to earnings – and questioned their prices, you were admitting that you didn’t understand the new economy. When I would NOT promise 100% returns, potential clients chose other advisors… who would.
In 2006, those who doubted the intelligence of zero-down (much less the 125% LTV mortgages) or questioned the wisdom of owning 5 homes met with popular mockery.
Today, just try to express skepticism about Tesla, Gamestock, or any of the popular crypto currencies. We recognize that “luck” has always played a role in short term investment success, but purposefully aggressive ignorance about risk management on new platforms like RobinHood has never worked very well in the long run.
Fourth, bubbles push pundits to outdo each other’s predictions. Whenever an asset goes up a lot, the race is on to signal who is the most bullish on that asset. The higher the predictions, the more the market moves… leading to ever more extreme predictions and ever-more overvalued assets.
During the height of the dot.com (1999), with the DJIA trading around 9500, Glassman & Hassett published their bestseller, Dow 36,000. Likewise, on March 20, Cathie Wood’s Ark Investments put a new target on Tesla — $3,000 (that is up from $665 today when every competitor in the market is gearing up to compete in the EV space).
When Bitcoin hit $10,000 for the first time (November 2017), Jim Cramer (of “They Know Nothing” fame) gave bitcoin its first $1 million price target and within a year it had doubled and then fallen back to $3,500. On March 4, 2021, a new call was made by a crypto CEO – that Bitcoin would go through the $1 million threshold and then… move on to “infinity.” It literally can’t get more ludicrous that this?
“It is difficult to get a man to understand something when his salary depends on his not understanding it.” – Upton Sinclair
Well, you can say that all four of Bernstein’s bubble markers are present, but happily they are only present in very tightly defined spheres. If you want to roll around in these spheres, you are likely to lose a lot of money. As an advisor of clients concerned with investment risk, we don’t.
Reminder — Our investment process
Our process is designed to work over long periods of time. We don’t make short-term directional market calls – because research has laid out how pointless the prediction racket is. We employ a disciplined, evidence-based process to invest our own and our clients long-term money and we make sure that we and our clients have enough cash for emergency needs as well as having access to capital they may need within a 5-year window. This investment process has 3 core elements:
- Plan appropriate asset allocation
- Broad, global diversification (we own it all)
Are we in a bubble now?
Remember that different parts of the global market move in different ways over different periods of time. It is easy to tell what has recently done well on a relative basis; it is impossible to know which parts will do well in the future on a relative basis. What we have right now is the knowledge that Large US Growth companies have done very well.
Over the last 10 years, Large U.S. Growth (IVW) is up 237%. If there is a general part of the market that may be in a bubble, this would be it (though the increase in price has largely been matched by an increase in earnings). Nevertheless, that is not “the” market; it is only “a” market. And rebalancing back to target will save you from being too invested when the inevitable switch or reversal arrives.
Over the same time period:
- Small US Value (IWN) is up over 110% (below long-term average).
- Large US Value (IVE) is up over 108% (below long-term average).
- Large developed X-USA (EFA) is only up 38% (well below long-term average).
- Large Emerging Market companies (EEM) are up a hair over 27% (well below long-term average).
The more concentrated you get in the most recent top performers, the more risk you might be in, hence a kind of bubble. So what? Do you think this means anything going forward? Do we know, based on these valuations whether domestic or international will do better next year or for the next 5 years? No! Absolutely not. It is unknowable.
“Sometimes you’re ahead, sometimes you’re behind. The race is long and, in the end, it’s only with yourself.” Baz Luhrmann – Sunscreen
If you invest properly, meaning broad diversification, you do not have to know what will work best in the next 12 months. We own (and always own) companies in the US and abroad; large companies and small companies; growth companies and value companies. And then we rebalance.
Instead of guessing what will do best (which has been proven over and over again not to work), we have a process that works regardless. It is almost never that exciting. It is never a top performer or a bottom performer. It Should Be Boring.
Once our investment process is in place, the most important thing we do is support the investor in keeping it in place. It is our fundamental belief in the future and our patient discipline in the face of unknowns that ultimately yields our greatest investment dividends.
Jonathan K. DeYoe is Founder and President Mindful Money, a Registered Investment Advisor. He is passionate about personal financial planning, financial literacy and helping clients achieve better outcomes through mindfulness. He is the author Mindful Money: Simple Practices for Reaching Your Financial Goals and Increasing Your Happiness Dividend.
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This material is solely for informational purposes. Advisory services are only offered to clients or prospective clients where Mindful Money and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Mindful Money unless a client service agreement is in place. Mindful Money is a service mark of DeYoe Wealth Management, Inc. a Registered Investment Adviser.