What’s the definition of a “bubble” in the market context?
That’s a question I’ve explored at some length in these pages over the years. At times, I’ve lapsed into frivolous semantics and pseudo-philosophy to the chagrin (I’m sure) of some readers.
But the bubble discussion is important. And that’s not as flippant a remark as it sounds.
Think about how often we toss the term around. “Bubble” is bandied about with reckless abandon. We all seem to agree that it carries a negative connotation when it’s applied to markets and the economy, but when pressed, we can’t actually define it.
That’s a problem. Surely, if asset bubbles are dangerous things with the potential to wreak unspeakable economic havoc, there should be some unanimity when it comes to what constitutes one.
In a new note, SocGen’s Arthur Van Slooten, Praveen Singh and Alain Bokobza argue there is no bubble and therefore talk of one bursting is nonsensical.
“With the S&P 500 up just a shade short of 90% in less than 15 months, it’s hardly surprising that investors are beginning to fear that the Bubble is about to Burst,” they wrote, before asking: “But then how do you define ‘Bubble’?”
The bank uses the “Triple B” spectrum, where that’s “Boom, Bubble, Burst.” The current rally obviously checks the “Boom” box. But SocGen’s cross-asset team “can’t convince [them]selves that the market is in Bubble territory just yet, let alone on the brink of an inevitable Bust.”
You may laugh, but, harkening back to the above, scoffing at the notion that we’re not in a bubble compels you to define “bubble.” Can you do it?
Van Slooten, Singh and Bokobza noted that a universally accepted characteristic of bubbles is “an unsustainably sharp price rise.” When couched in technical terms, they contend you need to see “a non-linear pattern on a log scale,” a situation that “inevitably lead[s] to a Bust to reset trading to ‘normal’ trends.”
Well, as the simple figure (above, from SocGen) shows, the Nasdaq isn’t a bubble. Or at least not on that “technical” definition. So, on a “performance” basis, SocGen doesn’t see a bubble.
How about on a valuation basis?
On that score, the bank conceded that multiples are stretched and that, historically speaking, “a simple glimpse at the CAPE chart could be enough to scare more than one investor.” Yes, indeed it could (figure below).
However, the same, familiar caveat applies. “Valuation levels are best gauged in the context of the current interest rate environment,” Van Slooten, Singh and Bokobza said.
You’ve heard that time and again, no doubt, but what you probably haven’t heard is a completely convincing explanation for why it isn’t correct.
During the pandemic era, rates have been at (or near) the lowest levels in 5,000 years. And I mean that literally (figure, below, from BofA).
Finally, SocGen looked at equities from a cross-asset perspective, quipping that “with real rates still in negative territory, maybe investors are looking in the wrong place for exuberance.” As for credit, it goes without saying that spreads are loitering near record tights.
The bank also looked at flows (which have been very robust in 2021) and positioning. The former almost checks the “bubble” box, but not quite, while the latter isn’t close on one of the bank’s multi-asset indicators.
You may or may not find the above convincing, but at a time when seemingly everyone has accepted, as fact, that equities are a “bubble,” it’s worth asking (again) what the definition of a “bubble” is in the market context.
I’m afraid “I know one when I see one,” doesn’t quite work.
While you’ll find no shortage of market participants willing to parrot that line (or some version thereof), there is a shortage of investors who can claim to have sold at the peak. If everyone who claimed (explicitly or otherwise) to be an accurate “bubble”-caller were actually as prescient as their rhetoric suggests, they’d all be quite a bit richer than they are.