Due to the lack of spending as a result of the global Pandemic and being flush with cash from the Fiscal Stimulus, some Americans are saving now more than ever before.¹ However, as interest rates are at historic lows, some of those founds have been invested into various asset classes, leading to unusual market behavior. Whether it’s purportedly Robinhood traders² or Wall Street Bets on Reddit³ or general investor euphoria⁴, various asset classes are breaking record highs.
The typical indicators of a bubble⁵ are as follows:
- Low interest rates
- Stock valuations that are divorced from earnings
- Retail investor mania
It’s seeming more and more likely that there are minor bubbles across multiple asset classes such as:
1. Stocks: The CAPE Ratio⁶ and Buffett Indicator⁷ are at record highs not seen since other major financial crises such as the Great Recession, the Dot Com Bubble, or even the Great Depression. For example, the S&P500 is valued at 22x predicted earnings (the historical average being 16).⁸
2. Real Estate: Although much less speculative than the stock market, housing prices are beginning to exceed income⁹.
3. Bitcoin: Volatile price shifts rendering it obsolete as a digital currency.¹⁰
This level of mania isn’t sustainable. A huge assumption of the market rallies seems to be that the COVID vaccines will succeed and then business will resume as normal, resulting in a huge increase in consumer spending and thus huge jumps in future earnings. However, the vaccine rollout has been slow¹¹, new variants have appeared which may not be adequately dealt with by existing vaccines¹², and the domestic dysfunctionality around managing the pandemic has allowed the virus to spread far and wide. Instead of a quick resolution of the pandemic, it is more likely now that it will likely drag out for years to come¹³. Thus, as the market is confronted with the new reality of a resurgence of the virus, it is only a matter of time before these historic rallies peak and begin to go in the opposite direction.
Indicator to Watch: Inflation Rate Spike
Once we’ve identified an asset bubble, the question is, what will trigger it to pop? The most likely candidate is a dramatic increase in inflation and corresponding interest rates. Under normal market circumstances, when inflation rates surpass 2%, the Federal Reserve typically will intervene and do a rate increase.¹⁴ The current inflation rate as of December 2020 is 1.4%, up from 1.2% from October / November, 1.3% in August, and 1% in July. The lowest it was in 2020 was April (0.3%) and May (0.1%).¹⁵
If the inflation rate holds steady, it’s unlikely the Federal Reserve will increase rates. But if there’s a huge jump in inflation, the Federal Reserve is likely to respond with an interest rate hike. If that happens and it comes as a surprise, that could trigger the popping of the bubbles — although it is notoriously difficult to time the market. If that bubble pops and the markets drop, that would be the best time to buy great stocks at a bargain price.
The next inflation rate update is scheduled for February 10th, 2021.
Note: While a spike in inflation is the most likely candidate for a market turn, another possible trigger of a market decline is a financial contagion that emerges from another part of the world which then spreads to the U.S.
- “More Americans Are Saving Than Ever Before, Though in Unequal Amounts” (Independent Tribune 2021)
- “Billionaires keep blaming Robinhood traders for skewing stock prices. But a new study says the upstarts have minimal impact on the overall market.” (Business Insider 2021)
- “Reddit traders look to pummel Wall Street’s old guard” (Axios 2021)
- “US stock rally drives ‘ludicrous index’ towards dotcom era heights” (Financial Times 2021)
- “Concerns grow about the stock bubble of the century — but what exactly would pop it?” (Financial Post 2021)
- “S&P 500 Has Only Been This Expensive One Other Time — At The Peak Of The Dot-Com Bubble” (Yahoo! Finance 2021)
- “The Warren Buffett Indicator Just Hit a Huge Sell Signal” (The Motley Fool 2021)
- “Is ‘hysterical’ market speculation pushing us towards another crash?” (The Guardian 2021)
- “The average family can’t afford to own a home in most U.S. counties — here’s why” (Market Watch 2021)
- “Bitcoin and U.S. tech stocks are the biggest market bubbles right now, investors say” (CNBC 2021)
- “World’s Economic Recovery Delayed by Slow Vaccine Rollouts.” (Bloomberg 2021)
- “Some COVID-19 mutations may dampen vaccine effectiveness” (AP 2021)
- “How the COVID-19 Pandemic Could End” (Scientific American 2021)
- “Powell sees no interest rate hikes on the horizon as long as inflation stays low” (CNBC 2021)
- “Current US Inflation Rates: 2000–2020” (US Inflation Calculator 2021)