Are We In A Bubble?
A pin lies in wait for every bubble and when the two eventually meet, a new wave of investors learn some very old lessons.
— Warren Buffett
An asset bubble can be defined as a rapid rise without underlying fundamentals in the price of an underlying asset such as stocks, bonds, real estate or commodities (Investopedia). However, often times the only way to know that you were in a bubble is only after it has burst. Until then, a fast-appreciating asset may appear overvalued, only to have its price continually rise. Anyone who has tried to blow one last breath into a ballooon already at its ‘limit’, finding it actually had the space for a few more breaths, would find this story familiar.
While there may be a substantial amount of literature on the internet on how to identify an asset bubble, often the reality is that it is much more complicated. Research by Yale’s William Goetzmann shows that it is actually extremely hard to pinpoint an asset bubble. His study showed that assets whose prices more than double over one to three years are twice as likely to double again in the same time frame as they are to lose more than half of their value. This research is in contrast to other available data regarding bubbles bursting, which only goes to show that identifying a bubble is incredibly difficult, let alone predicting the direction it could go. In essence, one should embrace the fact that there is a lack of certainty on the matter.
So are we in a bubble? The correct answer, non-conclusive as it may be, is “maybe”. Some specific assets such as housing and cryptocurrencies seem quite frothy. When looking at stock markets, the answer is mixed.
Latest URA data seen below shows that private residential prices are continuing their relentless march upwards. In addition, the first five months of 2021 has seen nearly 90 HDB flats sold for more than $1M, with the latest being a 49 year old HDB terrace transacted at $1.27M. Given the current ongoing pandemic, it is unlikely that salaries have increased dramatically to allow such deals. If this trend continues, this will likely bring about questions and complaints about the affordability of housing in Singapore.
Cryptocurrencies, have soared more than 500% in the last year. A phenomenal rise for an asset that does not produce cash flows and has a price trajectory seeming like that of large-capitalization growth stocks — the opposite of what one would expect from an asset meant to hedge against inflation and currency depreciation. Rational disagreements can occur over cryptocurrencies’ inherent value, but discussions today might have to include talk of bubbles.
The stock market might look mildly overvalued but when you dissect its components, the lower quality high momentum “growth” stocks are the ones which gives us some pause compared to higher quality value companies (referring to the chart below). This is why the majority of our portfolios — and your investments — have a greater weight to the value component of the stock market. Value stocks, in contrast, trade at prices below what company fundamentals suggest are reasonable. High-quality value stocks have underperformed the broad market by over 15 percentage points per year over the last decade and have only recently started to perk up again.
The demand for lower quality stocks carries on into the IPO space. In the US market alone, four out of five companies that offered shares on public markets for the first time in 2020 had earnings per share below zero. The percentage of such unprofitable IPOs has been nearly as high for the last several years, comparable to the numbers seen in the years leading up to the dot-com bubble. It may come as a surprise but of the unprofitable IPOs in 2020, more than 80% were in the technology and biotech sectors. The current situation could be setting up the opportunity for a hard landing for growth stocks.
Assets like property, cryptocurrency and growth stocks may continue their rise for some time to come, making many people that much richer. The research shows that it is hard to identify bubbles, let alone pinpoint when bubbles could end. However, at some point, we will be confronted with the issue surrounding the definition of asset bubbles — In what future scenario does the asset justify its price? As such, we will continue to stick to tried and tested academic principles and investment methodologies to manage our and your investments. Diversification, value, profitability and long-term investing will all come together to give you the investment outcome that we deserve.
