One Bank Asks: ‘What Bubble?’

One Bank Asks: ‘What Bubble?’

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.


 

12 thoughts on “One Bank Asks: ‘What Bubble?’

  1. For fun, I am reading some revised (2018) book by Burton Malkiel where he discusses “bubbles” in Chapter 4 without, as far as I can determine, defining what is a bubble. (It has been too long since I read the previous edition to recall any details.) Maybe a “bubble” is like a “snipe” and merely a figment of our imagination? Malkiel asks “What can make the bitcoin bubble deflate?” Having reached $20,000 at the end of 2017, surely bitcoin must be worthless or well below $20,000 now in 2021 based on Malkiel’s classification? Maybe bitcoin is like an underdamped, driven harmonic oscillator near the resonant frequency and has no upper bound? (I fear this possibility.)

  2. I always love the Bubble articles / efforts – incredibly stimulating and challenging to the mental facilities – I’m not sure the question is meant to be answered, … just pondered and reflected upon with investment strategies applied accordingly…

  3. That long-run trendline of the nasdaq log chart works out to be around 14% p.a. nominal.

    I guess the question is should we be expecting that same kind of total returns in a sub-4% nominal GDP world vs the 6% nominal GDP world of the past.

    1. Great question! As long as we’re talking definitions, SoGen posits a few determinants of what constitutes a bubble without the slightest nod to the context of so many other measures.

      For example, can equity prices be sustained a x level given the universal reliance on rates being proximal to zero indefinitely? Can equities withstand their price level if the Fed withdrew their massive liquidity intervention? Can markets survive (in terms of price) a deleveraging event such as we saw with RMBSs (residential mortgage-backed securities) in 2007-8? I ask because we are seeing CMBSs (the commercial version) are now placing banks, pensions, and the market in general, in the same risk profile.

      And a nod to Charm (above) for pointing out the same question about context re: GDP. And I’d add a note about risk vis-a-vis debt to GDP ratio. I know, Mr. H doesn’t truck in such metrics in the context of reserve currencies and I’ll allow his point but only insofar as the Fed gets requests for swap lines. When central banks ain’t calling, yours isn’t a reserve currency.

      Bottom line: shoe-shine boys aren’t signaling market tops like they use to. And who can say exuberance is irrational when so much money is being “made”? Say what you will, SocGen, but cherry picking market metrics to make this point isn’t moving my needle.

  4. The problem might not be in the definition, but in the wrong choice of word. Bubble may be fine for physics but not economics. Maybe markets don’t burst. Maybe the sun doesn’t circle the earth.

  5. I guess in the “I know it when I see it context” a bubble is simply defined as when an asset is being sold for multiples of it’s real valuation. With real estate I think that’s pretty easy to determine, right now just as in 04-08 homes are selling for way above their assessments. People buying homes today will be underwater if interest rates go up and buyers are no longer able to afford the same amount of home.

    With stocks it’s also pretty easy to come sort of conclusion on how much shares of a company should be worth based on underlying metrics. As with home prices, the bubble exists because the Fed has been keeping rates, to your point historically low, and is purchasing debt giving companies all sorts of cash to use for things like growth (stock buybacks), R&D (Executive compensation), and employee wage increases (layoffs). I kid but in all seriousness, we all know if the Fed raises rates and starts selling this whole thing is going to implode. (See December 2018)

    Crypto is probably the asset class that NOBODY knows the real value of. The meme coins seem to have no long term value but people buy them anyway because some famous guy pumps them. Other cryptos are trying to become some kind of global currency, it’s a lofty objective but one that would seem to drive some sort of speculative valuation. There is no way that ALL of these currencies are going to make it though, that means a number of them are being bought and sold for far more than they are actually worth (zero) hence a bubble.

  6. I may not know the definition of a bubble, but I know some of the signs. I remember in 2006 pondering the fact that my house went up more in value that year than I made working all year long and I remember thinking ‘WTF am I doing toiling each and every day when I could make just as much money hanging around maintaining my house?” That should have clued me in, but it didn’t. I did however have a sense of deja vu a couple weeks ago when an acquaintance who pressure washes buildings and houses for a living posted on facebook that he had just made 27 bitcoin purchases as the price dropped below $40k and was perturbed that he was seeing delays with the bitcoin exchange. He was positive that his future will be made by spending everything he has on buying the dips in bitcoin to end his life of hard physical labor.

  7. I recall feeling in either late 2019 or early 2020 the markets (and my well balanced portfolio gains) were “too good to be true.”
    In the investing space I don’t have that feeling very often…

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