Financial Compass: Bubble Trouble
We are now about eight years into the current bull market.
Downturns have been pretty mild, with only one borderline sort of bear market in 2011.
Some experts count 2011 to start the clock, and some use 2009. It has nevertheless been a long time since the last “big one,” 2008-09.
There is certainly nothing new about investment bubbles. They have been around since the Dutch tulip bulb mania in 1637. I assume that the only rationale for investing in tulip bulbs was just the idea that someone even more nuts than you would buy them at an even higher price.
The unknown is how far and for how long will the bubble expand before the inevitable meteoric ride back to planet Earth. There are always areas of so-called over- or undervaluation when it comes to investments.
One can view the over/under from many perspectives.
Investors often take a historical view and think “Aha! All-time high.” It might be absolute price or relative price to earnings (P/E ratio), interest rates, dividends or whatever.
The point to remember is that even extreme over-valuation (pick your mythology) doesn’t necessarily mean you have a bubble. These measurements might realistically be some of the criteria used to decide which investments to hold, but not necessarily to determine whether you are invested or holding cash.
The real differentiator between simply overvalued and bubble territory is the psychology of the bubble environment.
I don’t think the stock market is making headlines on the nightly news. Politics seems more the topic of the day rather than stocks.
When the market is “bubble-icious,” it’s on everyone’s discussion list, and I mean everyone. Remember the story about Joe Kennedy Sr. who found his shoeshine boy giving stock tips just before the 1929 crash?
The tech boom of the late 1990s had everyone bragging about the latest IPO that took off or the latest electronic gadget.
Probably for me, the scariest observation (warning sign) was all the people you might meet who had quit their jobs to become “professional traders.”
I always thought that these guys were really just unemployed and they would end up losing what little savings they had. Tell me you are a stock trader or a “consultant” and I’m thinking “unemployed.” Hey, I could be wrong!
For bubbles to be really inflated you need lots of hot air and the psychology of everyone being in a big rush to get rich. The idea that investments only need to be short term to make big profits would be the accepted rule. The bragging at cocktail parties has to be hot and heavy. No one ever brags about mistakes or how much they lost. It’s just like the stories about people who frequent the casinos talking only about the winning days or how they make a “living” gambling.
Give me a break!
Financial bubbles are comparable to other fads when they flame out. Beanie Babies, Atari video games, Pong, Frogger, Cabbage Patch dolls, they were all so popular that people fought over them until the eventual flame burned out.
The investment markets are generally most attractive when fear or at least skepticism is common, and dangerous when there is rampant greed or bubble-type behavior.
Patience is virtue
Especially after a period such as 2008-09, it is perfectly normal for the wounded investor to see market gains with suspicion. You have to stay invested to make money in a bull market. Patience is a real virtue as there are periods where gains are meager and skepticism grows.
Often it is a period that shakes out the impatient, nervous types only to see markets once again accelerate upward.
A recent LPL chart (tracking # 1-535435 expiration 9-17) shows current market valuation vs. the distribution of returns in the subsequent year.
The plots show practically no correlation with values even lower than the current price-earnings ratio ratio of 18.
At values as high as 25 P/E, the gaining years are outweighed by the down years, but not by as much as one might expect.
This is not to say there is no need for rational and prudent action (hedging) to keep risk appropriate to one’s own situation. Since timing market swings is generally recognized by most professionals as either a matter of luck or just a way to let emotions overrule reason, methodologies to reduce risk may also reduce the temptations to trade or push the panic button.
When your buddies are investment geniuses, the barber is passing out hot tips, your physician or dentist has business news on in the waiting room instead of Dr. Phil, that’s when to reduce risk in your portfolio.
• Note: Longer-term indicators are positive. Pullbacks in markets are normal and are generally not a reason to alter strategy.
Questions may be answered by contacting Don Hutchinson at 203-301-0133, in Milford, Safe Harbor Financial Management Securities offered through LPL Financial, member FINRA/SIPC. The opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial adviser before investing. Investing involves risks including the loss of principal. No strategy assures success or protects against loss. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.