History shows that when it comes to asset market gyrations, the pendulum rarely swings to the middle. When times are good, and money is easy, markets are prone to rise to over-inflated levels, forming bubbles that eventually burst and leave hordes of investors ruing the day they bought into them.
But while past bubbles have typically involved one specific asset class – tulip bulbs, tech stocks, railroad stocks, Florida land, mortgage bonds, cryptocurrency, etc., some contend that today’s bubble is different in that it involves not just one or two asset classes, but almost all of them.
What is the Everything Bubble?
This “everything bubble,” it has been said, extends from stocks and bonds to real estate, fine art, classic cars – just about anything those with wealth have been able to park their money in in the easy-money aftermath of the credit crisis of 2008.
These asset bubbles have been aided and abetted (some might say created) by the Federal Reserve Bank’s policy of lowering rates and injecting money directly into the financial system via its multiple quantitative easing (QE) programs.
Quantitative Easing
Quantitative easing saw the Federal Reserve purchase massive amounts of government and mortgage bonds from 2008 through 2014, thereby providing ample liquidity to spark frenzied buying across multiple asset classes, helping drive the stock market to a series of record highs.
Quantitative Tightening
The Fed has ended QE and switched to a policy of Quantitative Tightening (QT). Under QT, the Fed has started to raise rates, but the massive expansion of its balance sheet which supported the everything bubble is still far from being fully unwound.
The Federal Debt increased $11.6 trillion, or 122%, from January 2008 through January 2018, while during the same period nominal U.S. GDP only grew 37%. A reflection of this discrepancy between debt growth and economic growth in the consumer sector is the record levels of credit card debt despite the supposedly “booming” economy.
Normally, such a scenario would result in rising bond yields due to the lack of productivity associated with the increase in debt, but the Fed’s bond purchases have prevented rates from rising to the higher levels they would likely have reached in the absence of QE. This has led some to say that bond prices are in a bubble along with stocks and other assets.
Do Asset Valuations Matter?
When massive amounts of new money are being injected into the financial system, a case could be made for paying more attention to the momentum of asset prices rather than their value, at least in the short run. However, history has demonstrated time and time again that overvalued assets eventually return to their fair price – if not lower.
From the trough of the financial crisis in 2009, U.S. household wealth has exploded upwards, growing by around $46 trillion (83%) to reach $100.8 trillion.
While this astonishing explosion in wealth is certainly good news for those who have seen their wealth increase, some believe that this increase in wealth simply reflects the everything bubble’s impact, and that much of the wealth created during it will evaporate when the bubble bursts, much as happened in the aftermath of the dot.com and mortgage bubble-driven crashes of 2001 and 2008.
Seeking Shelter
If this is the case, investors looking for places to store their money could be in a quandary, given the evidence that many, if not most, asset markets appear to be overvalued at present.
Even after a significant decline, the stock market is still considered by some market observers to be richly priced.
In addition, real estate sales have slowed recently due to pricing that makes housing unaffordable to the average buyer, according to some market pundits.
While corporate bond yields have risen along with interest rates as a whole recently, it is not clear that their current prices represent bargains, given the high levels of debt many companies are saddled with due to the temptation of loading up on debt while the Fed kept interest rates (artificially, some believe) low.
Additionally, while rates have risen in the wake of the Fed’s rate increases, they are still quite low by historical standards, making interest rate risk (the risk that rates will rise further) another element for bond investors to take into account.
Out of the Frying Pan, Into the Fire?
If the stock market, bond market, and real estate market all appear to be overvalued, where do investors turn?
Unfortunately, in many past periods of easy money investors have pulled money from assets they believed were overvalued only to invest them in even riskier places.
For instance, mortgage bonds based on subprime lending in the run-up to the financial crisis of 2008. Another example comes from 1999, when it seemed that everyone and their brother wanted to buy into the latest hot internet stock, only to find that by mid-way through 2000 the dot.com boom had become the dot.bomb bust.
It is by no means clear that this time will be any different for investors chasing returns by investing in ever-riskier investments. The recent downturn in the FANG (Facebook, Apple, Netflix, Google) stocks after many years of stellar returns shows how the stock market can take as easily as it can give.
Will investors bruised by the FANG downturn who turn to investing in the latest hot sector, whether it be cryptocurrency stocks, cannabis stocks, etc. fare any better during the current period of overvaluation?
Declining Liquidity
If history is a guide, investing in risky assets during a time of declining liquidity is not likely to be rewarding. While some assets can do well even while other assets are falling, this generally occurs during what is called market rotation from an overvalued asset class to an undervalued one. However, if we are really in an everything bubble, finding undervalued assets to rotate your funds to becomes, if not mission impossible, at least a significant challenge.
If many real estate, stock, and bond investments are overvalued, the traditional asset allocation process of taking your profits from one asset class and moving them to another becomes problematic. In this scenario, cash and cash equivalent alternatives along with financial products which offer guaranteed returns become more attractive.
While such products don’t always provide the same return potential as more aggressive investments such as individual stocks or stock market-oriented mutual funds, they are more suitable for helping preserve your capital, especially in times of high market volatility.
With the recent declines in the stock market perhaps indicating that the everything bubble has begun to pop, or at least lose some air, such products that offer guaranteed returns are likely to increase in demand as investors become more focused on reducing risk.
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