Ask European fund managers what keeps them up at night and you might hear: “A bubble on Wall Street.”
That’s according to the January vintage of BofA’s European Fund Manager survey, released on Tuesday.
Overwrought euphoria in US equities ranked third on the list of tail risks, behind only COVID-19 vaccine distribution and a tantrum in the bond market. Inflation was number four and “fiscal policy drag” a distant sixth, behind “other.”
While anecdotal, this underscores the extent to which investors are becoming increasingly concerned about the situation in US equities which, for lack of a better way to say it, generally refuse to stop going up.
Valuations are extreme, although, as documented extensively in this instant classic, it’s difficult to say whether a given asset class is or isn’t a “bubble.”
In fact — and I think this is important — making such pronouncements is impossible.
Market participants, and especially veterans and those who’ve been lucky enough to have called tops previously, have a tendency to pass off subjective judgments as objective facts. Financial journalists do the same thing. Habitually.
Let me just put this as plainly as possible: The only way a reference to “bubbles” can be anything other than a subjective judgement is if the reference is to thin spheres of liquid enclosing air (or another gas). Those are bubbles. In a noun sense. There’s also a verb sense which also refers to an objective reality. You can boil something until it “bubbles,” for example.
Outside of those two instances, “bubble” is wholly subjective. So, when you look at the following simple chart, just know that describing it as a “bubble” is not only subjective, it’s meaningless. “Bubble” doesn’t mean “paying 30X for a dollar of earnings.” Again, “bubble,” as a noun, is a thin sphere of liquid enclosing air (or another gas). Period.
Now, you can call that (the chart) a “bubble” and people will generally understand what you’re trying to convey. In that sense, the subjective, adjective form of “bubble” serves a useful linguistic purpose. (And, yes, the word “bubble” as it applies to air-filled sacks, was just made up at some point, but it’s now universally recognized to describe a specific thing, and that specific thing is not any chart of the S&P 500’s P/E ratio or any other ratio for that matter).
The problem comes when asset managers and financial journalists use the term “bubble” as though it’s a noun that’s applicable to asset prices or, even more absurd, to charts that depict various measures which quantify a given relationship between asset prices and fundamentals.
This may all seem too philosophical to you, but my point is simply this: That chart is no more a “bubble” than it is a “car” or a “tree” or a “kitchen counter.”
Failing to make this distinction leads to all manner of spurious conclusions including, but by no means limited to, the notion that market timing is a good idea. Or that policymakers can be faulted for not “recognizing a bubble” as it inflates. It can also lose you a lot of money over time — just ask a blogger who’s spent the last decade (+) foretelling the apocalypse.
Let me give you an example. A journalist (and this time, it’s one I happen to like), wrote the following over the weekend in a newsletter:
But an actual bubble is unmissable.
It looks like this.
He then used some charts to illustrate the point.
Of course, if it were true that “an actual bubble is unmissable,” then that journalist, as well as everyone blessed with at least one working eyeball and a brokerage account, would be filthy rich by now. Because they’d have all bought every “bubble” on the way up, and shorted them precisely at the peak — “actual bubbles” being “unmissable” and such.
This is why people like Jeremy Grantham and Stan Druckenmiller have to keep adding superlatives the higher risk assets go. Last summer, Grantham saw a “Real McCoy bubble.” Druckenmiller saw “the worst risk-reward for equity in my career.”
Fast forward a few months and Druckenmiller’s asymmetric risk/reward profile was “an absolute raging mania.” And Grantham’s “Real McCoy” was “a fully-fledged humdinger.”
Go ahead and laugh. As I’m fond of reminding folks, it’s not a sin to laugh at these “legends.” The market “gods” won’t curse your P/L forever just because you chuckled at Druckenmiller. Sure, they’re “legends” in market circles, but let’s be honest here: What percentage of regular, everyday people around the world, do you reckon know who Stan Druckenmiller is? Or Jeremy Grantham? I guarantee you that percentage is less than 5% (and quite possibly less than 1%).
Here’s the reality: Markets are human constructs. They don’t exist without us. If humans disappear tomorrow, stocks, bonds, and the like, will trade until the electricity goes out on the algos. And then that will be the end of markets.
So, we can’t identify “bubbles” in “markets” because that’s an attempt to apply a noun which describes a totally unrelated thing that exists objectively (i.e., a thin sphere of liquid enclosing air or another gas) to what, ultimately, are make-believe constructs (i.e., stocks, bonds) which don’t exist objectively. It’s a misuse of language.
Not recognizing that is a good way to end up suffering from psychological distress manifested very often in the kind of cognitive dissonance illustrated in the figure (below).
That figure is from the same BofA survey cited here at the outset. It shows that despite fears of a “bubble,” 19% of investors in the poll are taking higher risk than normal.
As the bank noted, that’s “the highest reading ever.”
If risk assets were to careen 50% lower later this week, there would invariably be a parade of folks pointing to this article and laughing.
And it would be funny. Precisely because that would prove, beyond a shadow of a doubt, that those folks didn’t understand it.
The point of the article unless I am missing something is that the term bubble when applied to financial assets is a vastly overused term. I would have to agree with that. I would suggest that a better term and more applicable would be an asset class that has elements of “speculation”. Bitcoin comes to mind here as do other assets at various times as well. Many other assets could be termed “overvalued” but that term is far different that “bubble” which conotes an asset that is valued at a multiple of its instrinsic valuation.
The main point is actually that by virtue of not being real, none of this stuff is amenable to any kind of precision. Bitcoin is just an extreme manifestation. But any financial asset can be bid to infinity. There’s no objective definition of “overvalued” when it comes to an electronic piece of paper representing one unit of ownership (i.e., a “share”) in an entity (e.g., Walmart) which is itself a figment of our imagination, and which can issue as many shares as it pleases.
It’s important to recount these seemingly “silly” truths. We have a tendency, by virtue of occupation, to believe that things are true or real even though they aren’t.
And it leads to spurious conclusions about what will “probably” happen or about where this or that asset will “likely” end up. In reality, there’s no telling.
If an apple becomes detached from a tree, it will “probably” fall. The likelihood of that is near 100%.
There are no such rules governing anything to do with markets, money, or anything else created by us.
But we act like there are. So we do things like sell when some totally arbitrary indicator hits some totally arbitrary line we drew on a chart we made up. Or buy when a make-believe thing becomes worth less than its “fair value.” But the “fair value” of a make believe thing is zero.
People think this kind of discussion is ludicrous or a waste of time, but think about how much influence this make-believe stuff has over things that are real.
Sure, you can grow your own food, but most people don’t. And most people definitely don’t own any cows. So, whether or not you eat or drink milk, and especially what you eat or whether you get to buy the name brand or the store brand, etc. etc., generally depends on fluctuations in the value of things that aren’t real.
It’s the same with the environment. The fate of animals, the cleanliness of a given community’s water, etc. in many cases now depends on the generosity of companies. But companies aren’t real things. And neither is the money they spend to save a given species or clean up a given stream or local water supply via charity.
The made up stuff now reigns supreme over the real stuff.
When you live on an island, as I do, this becomes apparent each and every night walking down the beach. With nothing else around (no people, no devices, etc.) you become acutely aware of what’s real and what isn’t.
Sometimes, when I get back to the house, it takes me a few minutes to get over the absurdity of debating the “meaning” of, say, a 4 basis point move in Treasury yields.
You want a concrete example? I’ll give you one: Last year, according to markets, the value of a barrel of oil was (briefly) negative $36.
That’s an example of a real thing (oil) being totally subjugated to the make-believe.
I’ve somewhat evolved my thinking since about March 2020. I’m starting to try to think of market valuations as relative. I think I heard this concept during a Gundlach interview. I can’t remember. Not that it makes me feel better or that it engenders me to take more risk. Rather, the world has changed and I’m trying to change my thinking.
And, it’s not a “it’s different this time” kind of change in thinking to make myself feel better. It’s more about the monetary system advancing to some a reset and the possibility of a $40T Fed balance sheet. Sure, equities could crash 50% this week and I’d be sorry I wasn’t 80% cash.
pretty fascinating stuff, bubbles…I’m now at a place of seeing the markets as higher powers that I’m generally at the mercy of and have surrendered to, a rational and fundamental understanding that’s well over my pay grade so to speak… yes I own stocks and they’re doing well, but I’ve also sold many of the past years as I prepared to semi retire, and in hindsight had I held on to them I’d be much richer now, but my goal wasn’t to maximize my wealth, yet to be able to semi retire and I’ve met that … so now I’m mostly holding on and adding when I see value, mostly in companies with good dividend yields that appear able to at least maintain them while the rest works itself out economically, utilities such as PNW ED ENB, and T and even TLT recently as I believe in the orderliness of the current investment markets these days…Don’t own cryptos but I guess had I had the disposable wealth to do so these past years I probably would have and my guess is that is investors with money to burn are well invested in cryptos, TSLA, FAANG, etc … but back to bubbles, my rudimentary understanding is that they don’t follow a parabolic move higher but rather that parabolic move higher often has a period of significantly volatile consolidation that either resolves itself higher or lower, sometimes quite dramatically…what becomes identified as the triggering event is something that normally is well tolerated and absorbed by the markets under usual times but somehow manages to hit in the perfect storm of market risk to pop the bubble or start the avalanche. At some point one would think that reality must enter the equation…H. has reported that 92-95% of the world’s economies are in recession, something that hasn’t occurred in 150 years, the Coronavirus has permanently disrupted peoples’ lives around the world to the extent where the previous economic and wage earning realities are gone possibly forever, but at least for the next few years, and prior to 3/2020 my recollection was that global economic growth was trending slower and lower, and now with the pandemic and acceleration of disinflationary or deflationary technology that will remain well entrenched in our lives now going forward, it seems to add more negative disruption to economic fundamentals, so while there is hope in the current “recovery” and vaccine rollout, it seems inevitable that this hope will eventually meet reality and that meeting place may be very painful on many domains…just my two cents thanks …
Howard Marks latest missive accepts the possible dual market valuation scenario concurrence.
Here we are, lemmings on a narrow path that runs beside the edge of a cliff. Some young, some old, some smart, following you with our heads bent in reverence and concentration. Listening to your incantations, when suddenly you stop and say, “But wait. No matter how enthralling, these are just stories I tell you to understand other stories, to while away the hours, to keep marching in time. But these stories they are not real. This path is real. This cliff is real. Look. Feel the wind on your face and the earth beneath your feet. See the cliff’s edge. They are real. Do not be over-awed by the stories we tell each other. In the end the stories are made up, flawed and follow no laws of science. The cliff, the wind, the dirt, those are the only things that are real. Never forget.”
Lemmings that we are, we’re thrown into disarray by the sudden stop. A few fall over the edge. The rest wait for the story, more real than a cliff’s edge, to resume.
You appear to be on something of a philosophical kick, Heisenberg. Questioning the nature of reality and how it relates to and intersects with man-made constructs is a fine philosophical exercise. Have you read much Western philosophy?
I am less certain about the value of a semantic exercise as it relates to financial bubbles. Bubble has displaced the use of a term like mania because it presents an evocative image of the underlying phenomenon. Air (or gas) bubbles can grow significantly but tend to be unstable and generally end up bursting. Perhaps you object to the ubiquity of the word. What is certain is that pundits overuse the term exactly because of its resonance and power.
Predicting market outcomes is, as you suggest, an imprecise endeavor. However, I think that has less to do with the fact that markets are artificial constructs and more to do with the large number of variables and the complexity of the mechanisms involved in price discovery.
In any case, ‘made up stuff’ has reigned supreme over ‘real stuff’ since the invention of money.
I’ve read a ton of philosophy. It was my minor back in the days when minoring in a subject actually meant something. (So, a long, long time ago.)
At one point, my philosophy collection (books) was something I took a lot of pride in.
Then, during a breakup with a girlfriend who looked eerily like Tinker Bell (and I’m serous — the resemblance was literally eerie, to the point where it bothered me, especially when contrasted with a tattoo she had on her left shoulder which wasn’t exactly consistent with a children’s cartoon), I lost them.
It’s a story for another time, but suffice to say she kept two TVs, all of my DVDs (this was before streaming was ubiquitous) and the philosophy collection. Not because she cared about philosophy, but because she knew I was proud of that collection.
It was heartbreaking. Not the breakup. Losing the books.
Indeed heartbreaking. At least to me. My philosophy collection, decades old and which still expands by the week, is without question my ‘most valuable’ property.
you did retain a copy of Hararis book, though 😉
Thanks for the superb article, especially the last paragraph