Debunking Market Bubbles

Advice to the Advisors

young girl blowing bubbles, Sheaff Brock CIO on Market Bubbles

Debunking Market Bubbles

“The next time a client tells you that stocks are in a bubble, consider a polite way to say, ‘I don’t think that word means what you think it means,’” John Waggoner wrote back in August of 2016, citing Wharton School of Finance professor Jeremy Siegel. An overvalued market isn’t necessarily a bubble—the market must be 100%-200% above its fundamental value before it’s a bubble, Siegel taught.

Counseling clients about stock market bubbles is an indispensable part of a financial advisor’s job, U.S. News & World Report recently cautioned. As of 2021, the article posits, “it is getting more apparent that investors face the risk of losing wealth in the stock market and not making it back quickly.”

While the advent of commission-free investing apps such as Robin Hood (allowing newbie investors to purchase fractional shares with small dollar investments, no advisor guidance and essentially no barriers to entry) has resulted in increased speculative trading, Sheaff Brock’s Dave Gilreath believes that a good portion of that speculative activity has already been “baked into” stock market value.

On the other hand, recent headlines about a horde of newbie retail investors who, using the Reddit online forum WallStreetBets, were able to boost GameStop shares “in defiance of investing norms” serve as frightening reminders of the price to be paid for excessive exuberance. What’s more, Gilreath admits, the additional $1,400 subsidy payments might well trigger increased speculative trading.

Speculative bubbles are hardly a new phenomenon, Gilreath reminds our readers, recalling:

  • the raging U.S. stock market of the late 1920s
  • the Dotcom bubble of the 1990s
  • the U.S. housing bubble (home prices doubled from 1996 to 2006)

That stocks are overvalued is just one of several signals that we’re in a bubble, says David Seiler of Money Morning. Yet, he adds, the odds are we’ll see more all-time highs before we see a stock market crash. There are several reasons a crash is not likely to happen any time soon, Seller opines:

  • rising market optimism as more people receive COVID-19 vaccinations
  • U.S. Federal reserve policies with near-zero interest rates
  • generous lending to banks and state and local governments

Advisors may look to this Bloomberg chart titled “Are We in a Market Bubble? Probably Not…”  for reassurance. If you take out the COVID-19 drop, the authors demonstrate, through January 25, 2021, the S&P is up only 13% as opposed to the scary 72% that might suggest a bubble.

S&P 500® (12/31/19–1/25/21)

chart of S&P 500 gains from 2019 to 2021

Source: Bloomberg

2020 was a year of fear for many Americans, Jessica Menton points out in USA Today. Markets have since staged what she calls “a stunning turnaround,” defying a backdrop of historical job losses, bankruptcies, and shrinking corporate profits. Trillions of dollars in stimulus from the Federal Reserve and Congress have propped up the economy, causing Menton to conclude that “while the COVID-19 death toll is staggering, the stock market is telling Americans to be optimistic about 2021.”

Some speculative trading over recent months might indeed be considered “bubbles,” Sheaff Brock’s Gilreath agrees, but the stock market is a forward-looking animal; if advisors help clients avoid the speculation trap, he sees more good times ahead.

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