My dear Friends,

if you have found your first grey hair recently you presumably lived through an expectation bubble before, and it may have burned some of your capital.

The standard recipe for a bubble: is cheap money, easy access to assets, and a high degree of speculation.

Now here we are again; there is a lot of talk about a stock market bubble, a tech bubble, or a real-estate bubble.

But what are those bubbles, and why can expectation bubbles actually burn your capital?

Indicators

Bubbles need a combustion triangle to explode: Oxygen, heat and fuel, all three components must be present at precisely the same moment.

A financial bubble bursts if there is high market activity, easy access to credit and political or economic disruption.

Generally speaking, a financial bubble is an unsustainably high price for an asset class over a period of time. Once the bubble bursts, lots of money is lost, and economies or industries can be endangered.

Here are some of the indicators:

How it happened

Throughout 2021 many economists raised their voices and warned that the zero-interest rate policies of central banks in developed economies would lead to high inflation, a distortion of the stock markets and overinflated real-estate prices.

The markets have been flooded with “cheap” money for over ten years. Quantitative easing programs, the extensive bond-buying program by central banks, led to high bond prices, however, with almost zero yields.

Japan was the first to implement a zero-interest rate policy to combat the economic decline caused by the asset price bubble’s collapse (1990). However, with little effect, for 20 years, the economy remained in deflation. The Japanese economy was facing a liquidity trap as a result.

To combat the Great Recession (2008), the FED, the Bank of England, and the ECB lowered interest rates and started extensive bond-buying programmes to keep the global economy afloat.

With the start of the Covid-19 Pandemic, governments further lowered interest rates and intensified bond-buying programs to ease the economic stress various lockdowns caused.

Excessive money supply

Plenty of cheap money was made available, followed by extensive government investment packages. This made investors over-optimistic and fuelled speculation despite bad economic parameters.

Another side-effect of cheap money was that more companies bought back their shares. There are various reasons for doing this; it could be the best use of a company´s capital to increase shareholder value and make the company more attractive to investors by improving financial ratios.

Yet, it was not only the cheap money. Fintech and social media have created a new kind of retail investor.

When the times are good and when you’re making money, it all feels great. And when the times are bad and you’re losing, you can evaluate it like that and say, you know, ‘I don’t have a consistent paycheck.’ There’s no way to guarantee my future doing this.

AJ Vanover a lucky amateur trader who bought GameStop options and became a fulltime investor. Since November he’s discovering the challenges of giving up a regular paycheck.

Fintechs had “democratized” trading – anybody from everywhere could try their luck in trading by downloading an app. Lockdown measures had left many with plenty of spare time and money in their pockets, so more amateur traders entered the market. Many without any knowledge but plenty of advisors on social media platforms – the meme stock was born.

Bubbles or froth

A quarter of all global bonds had negative interest rates, while Tesla’s market capitalization surpassed all traditional car manufacturers in Japan, Europe and the US together.

Apple, Alphabet, and Microsoft became the most valuable companies in the world with a market capitalization of $2,5, $ 2,1 and $1,5 billion, respectively. In 2021, it was mostly tech companies that drove the S&P 500 to its 66^th all-time high.

The market for IPOs at the New York stock exchange was “hotter” than ever before. An average first-day performance of an IPO was 40%.

‘the most extreme financial bubble in US history’

John Hussman, Hussman Investment Trust

SPACs became the investor’s new darling and were the answer to an evergrowing demand for new emissions and a high-risk tolerance. In 2020 SPACs ” collected” a total of $70 billion – more than in the previous ten years altogether.

Bitcoin, a most speculative investment, increased its value fourfold within three-month. Other cryptocurrencies or crypto trading platforms were on an upward trajectory as well, however, with high volatility.

Bye, bye hoorays

Throughout 2021 reality caught up with investors. Will the economy really bounce back to pre-pandemic status? How sustainable will economic growth be? How and for how long will the shortage of commodities, utilities and labour affect economies? Will inflation be a short-term phenomenon, or is it going to stay? How will central banks react to rising inflation? Will geopolitical conflicts hamper the recovery of global economies?

Investors were willing to pay more for each dollar a company would earn, especially with regard to tech stocks and cryptocurrencies. Some are traded well above the company’s actual earnings or true value.

A negative yield means a company is not earning enough to keep up with inflation, but the share price is high.

Negative real earnings are rare and often precede a stock market slump. This happened in 2000 before the internet bubble burst and twice before during the 1970s and 1980s.

Is the bubble going to burst?

Various central banks in developed economies raised their concerns over high inflation rates. Many economists feel a correction of stock market prices is overdue.

The US Fed was the first to signal a rise in interest rates, and others will follow. This could be the spark to burst the bubble.

Now, here we are, and the big question remains can this expectation bubble go to burn our capital?

The best-case scenario is a slowing and correction of markets. Welcomed by many experts as they view this as healthy and overdue. Mark Zandi of Moody’s Analytics says: “So far, I view this as therapeutic”. Corrections are healthy within reason as long as they do not spiral into panic.

Cryptocurrencies are predicted to slump considerably; some predict Bitcoin to slump as fas $10.000. Investing in cryptocurrencies is investing in an expectation that, for some reason, the currency will be good for something other than speculation, and regulation will stay relaxed.

,Superbubbles are considered by quite a few as the most exhilarating financial experience of a lifetime.

Jeremy Grantham, Grantham, Mayo, & van Otterloo

We need to remind ourselves not all stocks are in the bubble; the emerging tech sector, cryptocurrencies and companies whose share prices have more to do with a faraway future than actual earnings seem to be most affected.

Hyperbole and crystal bowl

John Haussman, president of the Hussman Investment Trust, has built a reputation for being able to predict moments of speculative excess – he did so in 2000(dot. com bubble) and 2008 (housing Bubble).

Haussman states for tech stocks to return to their regular trend level, the S&P 500 would have to fall about 70%. With stocks selling off since he published the commentary on January 14, it would still have another 68% to go.

Hussman states these high valuations set the market up for dismal returns over the next decade. He forecasts prospects get better after the bubbles burst and the market bottoms.

Savita Subramanian, a Bank of America strategist, said that growth expectations were too high, and she expects negative returns over the next decade, considering valuations.

“Taper doesn’t necessarily mean downside risk to stocks, but it definitely indicates a slowing or a plateauing in this bull market.”

Savita Subramanian, Strategist, Vabnk of America

According to Subramanian, one trend that supported stocks for years was a constantly shrinking amount of shares, which pushed prices upward. It is her opinion that this will fade away. There will be less cheap money available to buy back shares, and more companies will go public.

Take away

It is essential to stay calm to stay afloat during an expectation bubble. Volatility will be high, and it is essential not to make a long-term decision in panic mode. Never forget investments are long-term, and there is always light at the end of the tunnel.

Most importantly, stay informed and chat with people who have financial confidence. Ignore the catchy headlines, and do not believe everything the news tells us.

There is too much panic-mongering at the moment; never forget the media needs to sell headlines, and people are bored by pandemic headlines.

Now might be the right moment to reevaluate your portfolio, sit down with your advisor, and brainstorm. It might be the right time to sell some assets and buy new ones in the dip.

Analysts at Bank of America advise against tech or consumption-related stocks but think utilities might be something you might want to look at. Advisors from UBS think health tech, real estate and green tech are assets worth looking at.

At the end of the day, you will have to make well-informed decisions that suit your needs and your long-term strategy. Get the right kind of information and make your decisions based on what makes sense to you. Above all, trust yourself!