There’s a point in every great stock market run when an uncomfortable feeling creeps in. When the investing hive mind starts to worry that the good times have gotten too good.
Once again, that moment is upon us. At times like this, the financial discourse inevitably circles back to the same question: Is this a bubble? While the answer is probably yes, it almost doesn’t matter anymore. We are living in the age of bubbles, and all an investor can do is learn to live within them.
Stock-market records are being broken around the world, even in countries facing recession. In the United States, large-cap stocks have rallied fiercely, gaining 25 per cent in five months, which has happened just 10 times in the last century. Gold and crypto recently entered record territory. Even the unloved TSX is on the cusp of rising past its high-water mark set in 2022.
Now, it wouldn’t be the stock market without the odd bout of euphoric excess. But it’s not hard to argue that bubbles inflate much more quickly and frequently in today’s fast-moving markets. Blame pandemic stimulus, easier access to financial markets or the high risk tolerance of a generation of investors that came of age in a golden era for stocks.
“There’s probably still too much money floating around.” said Craig Basinger, chief market strategist at Purpose Investments. “People just jump on these things a lot faster now.”
The market has certainly jumped back into the bitcoin frenzy with abandon this year. It’s been just over two months since the first exchanged-traded funds holding bitcoin were launched in the U.S., and already investors have committed net funds of more than US$11-billion.
Intense demand plus soaring bitcoin prices have seen assets in the 10 U.S. bitcoin ETFs rise to more than US$60-billion.
And of course there is the stampede into artificial intelligence. Nvidia Corp. NVDA-Q, whose computer chips are powering the AI boom, has seen its market value rise by US$1-trillion over the past two months alone.
You don’t exactly have to cherry pick the financial data to find other signs that markets are brimming with enthusiasm.
This past week, the closely watched Investors Intelligence market sentiment survey showed an extreme spread in the balance of power between bulls and bears, with the pessimistic camp falling to 14.5 per cent – the lowest reading in six years.
The risk in having too much optimism is that discipline is increasingly discarded by investors chasing big gains until the last traces of skepticism are wrung out of the market.
We are not at those extremes of exuberance quite yet. But the bullish trend is undeniably taking hold.
Consider how the market handled some disappointing inflation news this past week. On Tuesday, the U.S. Bureau of Labor Statistics reported that consumer prices rose by 3.2 per cent in February year-over-year.
The data point reinforced the difficulty in getting inflation back to target and further doused hopes for rate cuts. Just a few months ago, this kind of bad news would have, at the very least, spoiled the market’s mood for the better part of a week.
But suddenly, the bull market is just fine without rate cuts. The S&P 500 ended the day at a record high. It was the benchmark’s 17th closing high this year – the most in the first 50 trading days of any year since 1998, according to Bespoke Investment Group.
Does that amount to a bubble in U.S. stocks? Again, probably. But that doesn’t mean it will burst anytime soon. Let’s say it keeps inflating until valuations reach their peak in the dot-com mania. That scenario would see the S&P 500 rise by another 25 per cent, which would likely take until the end of next year, John Higgins, chief markets economist at Capital Economics, wrote in a note last month.
Yes, U.S. stocks are already expensive at about 21 times forward earnings, compared with the long-term average of 16. In fact, the S&P 500 is richly priced on 19 of 20 metrics laid out by Bank of America analysts. But the mass euphoria that has traditionally been the death knell of bull markets is generally limited to specific themes like AI, cryptocurrencies and weight-loss drugs, they said.
It is not yet a market-wide mega-bubble like we had in 2021. Back then, investors went from the panic and shock of the global pandemic’s onset to all-consuming stock market frenzy in a matter of months.
The sheer speed with which bubbles can form nowadays stems from a couple of powerful forces Mr. Basinger laid out in a report. Growth in U.S. money supply, which has historically tracked GDP growth, accelerated after the global financial crisis, and leapt higher through the pandemic. That means more money chasing returns in the stock market.
Additionally, an army of retail investors has piled into investing fads in recent years, enabled by cheap, easy access to markets and emboldened by big gains.
What is the cautious investor to do? Avoiding market bubbles would mean missing out on some of the market’s greatest runs.
Rebalancing can certainly help. Widespread bubbles can cause parts of a portfolio to swell to dangerous proportions. A regular system of right-sizing restores appropriate levels of risk by trimming one’s winners and putting that money into undervalued assets. For more active investors, tools such as stop-loss orders can limit the damage from bursting bubbles. These trigger a sell order once a stock declines to a certain price level. “Having a thoughtful, disciplined approach that incorporates some hard trading rules can go a long way in enjoying success in our bubbly world,” Mr. Basinger said.
Tim Shufelt