You can deconstruct the current bull market any which way and six ways to Sunday. In previous blogs, we have provided the reason for the current bull market as being outside the normal business cycle definition… the rise of the “non-fundamentals.” Government intervention forced investors to seek a different paradigm when it came to their portfolio – strength, sentiment and safety.
We have pointed out that regardless of those “non-fundamentals,” you still have traditional market indices – the fundamentals – which have been screaming for a correction for years. Yet the bear market correction has not come.
So, what can (and will) cause the next bear market? A bubble. More specifically, lots of bubbles. Any one speculative bubble could cause a market downturn and there are several that could happen at the same time, wreaking havoc across the financial world.
What is a bubble exactly? A bubble (speculative bubble, financial bubble, asset bubble, economic bubble, et al. are all basically the same event in macroeconomics) “…is trade in an asset at a price or price range that strongly exceeds the asset’s intrinsic value. It could also be described as a situation in which asset prices appear to be based on implausible or inconsistent views about the future.”
Let’s take a look at some of the worst in history, and what could be the next bubble to burst and cause a stock market reversal.
I. Our Top 3 Speculative Bubbles in History:
- Tulipmania grips the Dutch Republic in the 17th Century. What is believed to be the first financial bubble to burst in recorded history, the Dutch Republic grappled with what appeared to be in retrospect the ludicrous public desire for “tulips.” At the height of the bubble, tulips were selling for 10 times more than the cost to bring them to market. Tulips were first sent to Europe as a gift from the Ottoman Empire in the mid-16th century. By the mid-17th, people were trading 12 acres of farmland for a single tulip bulb. The first futures bidding occurred on a “stock” market as buyers committed to purchases by contract on a future date. Record-keeping from that time must be pieced together, and most historians saw the market collapse due to tulips around 1637. The Bubonic Plague was keeping buyers from the public market, and when few showed up for a public auction in Haarlem, the sell-off began immediately.
- Dot.com 2000 – by 2002, the Nasdaq had lost 78% from the top. From 1995 through October 1999, if you worked out of your garage but had a website and “.com” on your name, you were stock market gold. Companies with no earnings, some which wrote on their SEC filings that they had no business plan to generate profits, were still being minted with multi-million-dollar market caps seemingly overnight. The explicit belief in this perfectly defined “bubble” was that the new technology of the internet could make any company profitable. In 1999, 457 companies launched IPOs, and 117 doubled their stock price or higher the next day of trading. The euphoria subsided shortly thereafter, with a slow pull back beginning in March of 2000. The dot.com bubble officially burst by the 4th quarter of 2001, aided by the 9/11 attacks. The bottom for the NASDAQ was reached in October 2002.
- The Real Estate Bubble of 2008. In 2008, we saw the darkest hours of the Real Estate Bubble in the United States. However, the market collapse in home values began in Florida in late 2006. Ripples in the market were beginning in the fall of 2007, as we began what would become a recession. Bear Stearns collapsed in January of 2008, and the government seized Fannie Mae and Freddie Mac in the summer of 2008. But the one day fall in the stock market right after the collapse of Lehman Brothers is considered the seminal moment in the crisis which gripped the country. The government had forced banks for decades to loan to poor credit borrowers, but several events occurred which made the market surge skyrocket right after the dot.com bubble had finished. (A) The government removed the Glass-Steagall regulation… now banks could use deposit money to trade with for the first time in decades; (B) the government allowed a higher percentage of mortgage notes to be bought and held by Fannie Mae and Freddie Mac; (C) the already forced lending into “red-line” districts led to more defaults… in the 2000s the government increased the allowable number of loans funded by subprime lending; (D) these toxic mortgages – derivative notes sliced up and sold as mortgage backed securities, including those funded to poor credit borrowers – began defaulting on the Adjustable Rate Mortgage notes in the mid to late 2000s. The result was a sell-off in real estate which collapsed bank lending, insurance, and almost collapsed the entire financial system.
Tulip-mania, dot.com, 2008 … all were bubbles where buyers acted with irrational exuberance. Once the pricing mechanism failed, and there was a reversal, the market went into free fall.
There are several bubbles we could be living through right now, and could bust the U.S. stock market bubble any day now:
II. 3 Potential Speculative Bubbles That Could Mean a Worse Financial Crisis Than We Saw in 2008:
- China. Bad real estate debt, bad consumer loans, private Chinese citizens defaulting on debt owed to foreign banks… it is easy to become an economic power when all you have to do is copy, and steal, the economy of the United States for several decades. The Chinese began to manipulate their currency in an effort to keep their stock market afloat in late 2015, as more and more of these issues were beginning to go public. If China has a series of defaults, or a continued decline in economic growth, a recession or outright contraction could send their stock market, and the global economy, into a tailspin.
- Real Estate in the U.S. showing signs that were just the same in the pre-real estate bubble of 2008. Does any of this sound familiar? Stated income loans are back. Housing prices back to 2008 levels in many markets, and in some cases even higher. Housing prices rising faster than salaries. The government was (and is) buying much of the paper allowing investors to drive up prices because of minimal risk. Foreign demand was the hottest over the last several years, but we are seeing a slow down… is this the first stage of a correction? All of these elements were present right before the collapse in 2008.
- Bonds in bubble territory. Robert C. Pozen, a senior lecturer at MIT Sloan School of Management offered his assessment recently in the Wall Street Journal, “…. bond yields are at historic lows, but also because investors are gravitating to lower-quality and longer-term bonds with higher risks. When these risks become realities, bond investors will flock to the exits—reducing liquidity and further depressing bond prices. If the bubble deflates, bond holders will experience deep declines in the current value of their bond portfolios.” What does this mean? If you own bonds, run for the hills!!!
Many of these elements were present prior to the last stock market collapse in 2008 when all your portfolios were hit with massive reductions in value. “In it for the long haul” and ”Only paper losses” may have been phrases you heard. If you had principal protection investments, you did not lose money in 2008 like so many others. If the evidence suggests the market is overvalued in the same manner it was in 2008, would it not be prudent to put some of your gains away in a fully protected investment vehicle? We are due for a correction – do you know when it is coming?
Call now to have one of our advisors review your financial situation and give you the right direction for your principal protection needs. 877-912-1919