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Frequency of massive bubbles increasing - thoughts on if and why?


LongHaul
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I am not sure of this but perhaps the frequency of massive bubbles (in the US) is increasing.

That is my current hypothesis.

 

1999 - internet bubble

2006 - Housing bubble

2007 - stock market bubble

2017 - bitcoin

2018 - stock market bubble

 

In less than 20 years humans have gone totally nuts in the US 4-5 times. 

 

Some of you will disagree with some of what I have classified as bubbles and the current ones may only be seen in hindsight.

The question is, why is this likely happening with increasing frequency?

 

And this is when:

1.  There is more information available (internet, books, etc) than ever before. 

 

Some likely explanations:

1.  Increasing Social pressures from increased exposure to the internet (news, quotes, facebook, etc)

2.  More information but less deep learning and thinking.  Smart phones and the internet are distracting us and overfilling our brains.

3.  Less patience because we are used to things happening fast, so conditions us to be less patient.

 

These are just some of my thoughts.  Curious of what others think.  Feel free to post on this after a few days reflection.

 

 

 

 

 

 

 

 

 

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My experience is the average person really isn't thinking too much about bubbles.  This includes some very smart and successful people.  They just want to invest, they see something is moving up, they are aware that they might get killed on the position but there is a sense that everything is a bit of a gamble so what the hell. 

 

It is not really what you are after but fundamentally I just find that most investors aren't interested in applying valuation frameworks to their investments.  Housing is probably an exception but then when I think of Vancouver, maybe it isn't an exception.

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Hey all:

 

There is not a doubt in my mind (in America) that people are getting more & more stupider as time progresses.

 

In many places in America, the edukation system is broken OR rapidly breaking down.  People graduate from high skool with no knowledge of finances OR economics.  They don't even know how to balance a check book.

 

They have no knowledge of insurance, mortgages, how the stock market works, real estate, time value of money and dozens of other concepts....so if they don't have any exposure to these things, how are they going spot a bubble?  Have they even heard of "bubbles"?  How would they know?

 

I am now middle aged...but sometimes I work with "younger" attorneys (30 years old).  A good number of these people have little to no knowledge of finance/economics.  These are supposedly highly educated people.

 

Another thing I've started to notice is the SHOCKING number of children being raised in single parent households.  These single parent households usually are missing the father.  I've heard about this for a long time, but it is only in the past 3-5 years that I've really started to notice it.  This is not a good way to raise children.

 

Another factor I've seen is that SO MANY children are being raised in daycare centers.  The parent(s) drop the child off at day care while they work.  Sometimes this is with almost newborn children!  Obviously there is no other way for a lot of people...but once again, this is not a good way to raise children.

 

Obviously, another factor has been low interest rates.  That may be the single biggest factor in the blowing of bubbles.  I think a LOT of people have put money into the market, real estate, bit coin, beanie babies, or whatever because they can only get 1% in savings accounts. 

 

Finally, I'm starting to see another bubble in real estate.  Here in Detroit, housing prices are going UP!  WTF?  Over time, housing & real estate usually goes down!  So if it is going up, you know something crazy is going on!

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We just recognize that ever since Lehman Brothers, & prior - the west has experienced continuous rounds of aggressive central bank stimulation to avoid another global depression. As at today, there is 10 years+ of stimulation - that hasn't unwound yet.

 

The major central banks have finally slowly begun to raise interest rates. To use a kitchen reference; the chefs have noted the pot is starting to boil, and turned down the heat. Problem is that the bigger the pot (10 years of stimulus), the harder it is to control.

 

Today we have blockchain fundamentally disrupting long standing business practices, and a level of global 'political risk' that is a lot higher that it was 10 years ago. Added to which is growing recognition that to make the big money (via derivatives); is to systemically bet against stability. El Diablo has a lot of helpers.

 

It's hard to see how we don't get more bubbles, more frequently, and how they would not feed into each other at some level. And as algorithms only work under stable conditions, and until they don't work - the frequency and size of 'discontinuities' should be nice and high. Not your dad's market.

 

SD

 

 

 

 

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It's far from clear that it's true and it's certainly easier for me to recall more recent events when I've been an active investor than events in the 80s and early 90s when I was not and was also less aware of events in the US than the UK, but I suspect the speed with which many participants can now act, the reduced frictional cost of trading and the variety and speed of transmission of information, news, misinformation and ideas could contribute to increased bubble frequency if it is increasing.

 

The difficulty in gauging whether frequency is increasing is the availability bias - things more recent are easier to recall. You need a systematic way of searching for these things.

 

Perhaps a fairly good way of counting bubbles or recessions over many decades would be to look at the writings of someone with a consistent regular habit of commenting on the economy and its bubbles and recessions. I'd suggest the Berkshire Hathaway Chairman's Letter would probably be fairly consistent barometer of bubbles, panics and crises over time, by which you could gauge what one fairly consistent and rational person considers to be worthy of comment. I've learned a lot about problems from before my investing life, such as the Savings and Loan scandals from reading Buffett's annual reports.

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I think you're right! I expect bubble frequency to increase, very simply here's why:

 

- more instant data in front of more eyeballs - exacerbating the fear and greed cycle.

- less analysis (it's easy to be an indexer) and increased FOMO and lemming like behavior

- much,much shorter time horizon

- way more noise

- easy credit

 

I remember seeing a academic paper over 10 years ago that showed a graph, that went upper left to lower right. X axis being years held, and Y axis risk of loss. As it turned out, if you owned a security for more than 5 years, you're actual chance of loss was very low, assuming you just bought a middle of the road business That has always resonated with me. Who owns a security for 5 years these days? My Grandmother did. My Great-aunt who is currently 102.5, still own Fortis (FTS.TO) which she bought around 1978.

 

I think this short termism will be a benefit to active value oriented investors - but the ride is going to be bumpy.

 

What takes us over the next waterfall? Corporate debt?

 

 

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If anything, I see a bubble in people calling out "bubbles". Otherwise, it is same old, same old. Nothing much has changed.

 

We first need to have a working definition of a bubble. Rob Arnott's definition would be a good starting point,

 

We define a bubble as a circumstance in which asset prices 1) offer little chance of any positive risk premium relative to bonds or cash, using any reasonable projection of expected cash flows, and 2) are sustained because investors believe they can sell the asset to someone else for a higher price tomorrow, with little regard for the underlying fundamentals.

 

By this definition, I would put only the dot com stocks in the late 1990's and the housing market in 2005 as a bubble. Others cases do not meet the criteria.

 

I do not think we are having more bubbles nowadays than we had in the past.

 

It is just that people scare themselves silly, looking for bubbles everywhere.

 

High prices? Yes. Bubbles? No.

 

Vinod

 

 

 

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Hey all:

 

There is not a doubt in my mind (in America) that people are getting more & more stupider as time progresses.

 

 

I think since time immemorial, the previous generation probably always thought the next generation is going to hell in a hand basket.

 

I think the new generation is going to be better than the past.

 

Vinod

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+1 to vinod1 from me too.

 

I concur about the promise of many members of the younger generation and the overeagerness to call bubbles. I think the latter can lead to a lot of people to miss out on time-in-the-market by trying too hard in timing the market often at a cost to their long-term returns.

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Doesn't ease of participation play a role as well? If someone can participate in BTC when all their friends are already in by just downloading an app on their phone and transferring some money into their account and clicking buy, all done within 10 minutes, the participation as a percentage of the population is significantly higher than even in the late 90s.

 

Think of the various barriers to entry that have existed when it comes to participating in various financial markets, I can imagine in the 1920s a lot of people wanted to get in to the stock market but filling out the requisite paperwork and transferring the money to your broker whittled down the number of people who actually followed through significantly. The 90s internet bubble saw the birth of online trading accounts, making participation easier than it had ever been.

 

And now participation has almost no barriers to entry when done through a phone app, and perhaps more importantly can be done immediately when social pressure is at its highest - not, oh I'll go home and talk to the wife about it and setup an account. So yeah, social "FOMO" plays a role but the fact that there are almost no barriers to entry into participating in the latest bubble, coupled with FOMO, means everyone can easily participate. Add in things like social sharing and gamification and participation becomes not only easy but a competition amongst friends.

 

 

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By this definition, I would put only the dot com stocks in the late 1990's and the housing market in 2005 as a bubble. Others cases do not meet the criteria.

 

Vinod

 

IMO there's a lot of monday morning quarterbacking going on with the 2005 housing bubble.  Most simply sight the case shiller chart, but by that logic, why did Australian Housing prices keep going up?  Its really tough to identify a bubble in real time.

 

https://www.ampcapital.com/AMPCapitalGlobal/media/contents/Blog/olivers-insights/2014/April/03.04/chart-3.png

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I won't use the b word, but I do think the sharp swings over the past couple of decades owes a lot to Fed intervention and ballooning debt.

 

The Fed bailed out the economy during the savings and loans "crisis" and then again during LTCM then again after the dot com boom (which led to the housing/credit crisis). If you let one of these events play out, I doubt the others would have been that bad.

 

Now, we're basically in a position that the middle class is squeezed and the economy stays afloat due to government spending and low interest rates.

 

Not to turn this into the political thread, but the Fed should let capitalism work (even when people get hurt).

 

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Not all excess or overvaluation is a bubble. The market doesn't spend much time right on the "historical average" line, it's usually swinging back and forth between over and under. So while I think we've had some bubbles in the recent past, I think some of what many people are qualifying as bubble doesn't fit that description, at least for my understanding.

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With bubbles there are always methodological questions, as in exactly what defines a bubble, and how do you define it concurrently!  One leading historian makes the case that even the tulip bulb 'craze' was not a bubble! 

 

https://theconversation.com/tulip-mania-the-classic-story-of-a-dutch-financial-bubble-is-mostly-wrong-91413

 

I spilled my coffee reading that one.

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If anything, I see a bubble in people calling out "bubbles". Otherwise, it is same old, same old. Nothing much has changed.

 

We first need to have a working definition of a bubble. Rob Arnott's definition would be a good starting point,

 

We define a bubble as a circumstance in which asset prices 1) offer little chance of any positive risk premium relative to bonds or cash, using any reasonable projection of expected cash flows, and 2) are sustained because investors believe they can sell the asset to someone else for a higher price tomorrow, with little regard for the underlying fundamentals.

 

By this definition, I would put only the dot com stocks in the late 1990's and the housing market in 2005 as a bubble. Others cases do not meet the criteria.

 

I do not think we are having more bubbles nowadays than we had in the past.

 

It is just that people scare themselves silly, looking for bubbles everywhere.

 

High prices? Yes. Bubbles? No.

 

Vinod

 

Vinod,

This post is not to pick on you. Just trying to understand.

BTW, spending most of my time these days trying to find individual issues selling below intrinsic value. (aren't we all?)

Still, interesting to occasionally have a "feel" for the environment.

Don't know if bubbles are becoming more or less frequent.

The challenge is that bubbles, almost by definition, are recognized only in hindsight.

It's possible that many "bubbles" were never recognized because imbalances did not reach a certain threshold or because a certain confluence of factors was simply absent, allowing the imbalances to correct over time.

So, let's stay away from the bubble terminology and try to assess, à la Grantham, how far the market is swinging from the norm.

 

On this Board, on December 1st, 2009 (yes there was a discussion about a bubble forming then...), you mentioned:

 

"Agree on the sanity check. I think we disagree due to differences in what is meant by a bubble. To me that means a near unambigous and demonstratable overvaluation. Take S&P 500 in 2000, at its peak of 1500 its dividend yield of 0.9% and normalized PE's in the 40's the expected real return on stocks in the long term is less than the return available on TIPS which at that time were having a real yield of 4.5%. This to me is a clear and demonstratable case of a bubble.

 

Take the present situation, using any of the most commonly used methods of estimating fair value for S&P 500, leads to a fair value range in the 850-1000. With nominal treasury yields in the 3-4% range and TIPS real yields around 2%, the expected returns on stocks over the very long term is much higher than bonds. It looks a little expensive but no where near the bubble range."

 

The S&P was around 1300 then but I agree with your assessment of "fair value" for the S&P at that point.

If you try to think like Mr. Buffett (at least from what he wrote in 1999, see below), what happened to the S&P, since your quoted post, is very interesting.

http://archive.fortune.com/magazines/fortune/fortune_archive/1999/11/22/269071/index.htm

 

If you follow Mr. Buffett's logic about how growth of the S&P should be connected to the GDP growth over the long term, starting with your assessment of "fair value" then, the S&P should trade between 1100 and 1300 today.  ???

 

Helpful variables:

-S&P profit margin over GDP:    2010: +/- 10%    now: +/- 10%

-10 year government yield:        end 2010: 3,3%    now: +/- 3,0%

-the S&P index closed at +/- 2650 today

 

What "explains" (math point of view) the difference between projected and realized is that, for the S&P 500, PE went from +/- 16 to +/- 25.

 

Of course the best may yet to come but one should perhaps discounts the possibility that PE stays at the same level (or even decreases?).

 

I agree that one should look from the bottom up, but when I look at an opportunity that sells for twice fair value, I tend to wonder (and, bubble or no bubble, unambiguously go for the next idea).

 

So, this discussion does not change what I do day to day but I wonder if general expectations are in line with historical parameters.

Or is it different this time?

 

 

 

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Cigarbutt,

 

Snce 2009, I changed my mind on two points relevant to S&P 500 valuation:

 

1. Mean reversion of profit margins. I must have spent several hundreds of hours thinking and researching this issue over the last 17 years. I would not go into detail, but I no longer expect mean reversion of profit margins on a sustained basis to the levels of the period before 1980s. Not saying profit margins dont fluctuate or go down. Just the mean has shifted to a much higher level than the past. It might shift lower again sometime in future but not anytime soon.

 

2. Expected returns on stock market. I previously expected real returns of 6 to 7% as fair value for the stock market. With inflation of 2-3%, nominal returns of around 9%. In line with what stocks had historically provided. I now think fair value for stock market would be lower returns that this for a several reasons:

 

a) Even though 9% were the realized returns historically, it is very expensive in the past to get those returns. And few could actually get this return from a diversified portfolio. Think how expensive it would have been in 1900 or 1920 for a person to build a diversified portfolio of stocks to get this return. Think of the difficulty of getting relevant information about companies financials. Think of broker costs, transaction costs, etc. Fraud costs involved with physical shares. Risk of losing those physical shares, etc. A lot of the 9% expected or realized return on stock market would have been consumed by this. So if a person wants to hold 50 stocks, I would think that these costs could easily eat up 2% or more of the return. Now you can get a very diversified portfolio for less than 0.1% cost. So the expected return that the investor could actually realize has gone up by nearly 2% just from these lower costs.

 

b) Economic risks have gone down as well. Look at the frequency and magnitude of the recessions in the past compared to now (ya even with the 2008 Great Recession). This should naturally reduce the stock risk premium as well.

 

c) Inflation risk has gone down as well.

 

When you take all these factors (a, b & c) into account and consider that cash/bond returns are also going to be low (low real rate + low inflation + low inflation risk premium), then a higher multiple can be justified for S&P 500.

 

So not only are normalized earnings much higher in 2017 than I expected in 2009 (due to point #1) but the multiple that can be justified is also much higher than I expected in 2009 (due to point #2).

 

So I was actually wrong in my assessment of S&P 500 value in 2009. I made the mistake of reducing my allocation due to this a couple of years later. But was saved from this mistake due to opportunity in financials in 2011/12 period.

 

I actually reduced allocation in 2006/7/8 due to worries about profit margins and mean reversion. When markets fell in 2008/9 I felt vindicated. I was wrong of course.  But got bailed out by the financial crisis in 2008/9. The reason I changed my mind about profit margins/mean reversion is that when reducing allocation in 2006/7/8, I made a note to myself that if profit margins again go up in 5 years, then I should take a hard look at this issue again.

 

Vinod

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Thanks for the reply.

I don't use the same prisms and your perspective is helpful in terms of mind preparation.

 

Just to add a quote from a 2015 report I read from Morningstar reviewing the evolution of "costs" and "fees" from the previous 10 years:

 

"...industry fee revenue is at an all-time high, reaching $88 billion, up from $50 billion 10 years ago. During that period, industry assets under management have increased 143% while the asset weighted expense ratio has declined 27%, and industry fee revenue has grown by approximately 78%. Thus, a much larger share of the benefits of the increase in assets under management has stayed with the industry rather than being returned to fund shareholders."

 

To conclude, another quote (modified) from the investment industry:

 

"Past performance is not indicative of future results", unless the conditions that led to the past performance remain unchanged.

 

 

 

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Cigarbutt,

 

If I came across as bullish, I am not. I am more agnostic about market valuations. Do not have very strong views either way.

 

We have less than 150 years of data for the stock market. If you define a long term hold of 30 years as one representative sample. We have about 5 samples in stock market of long term returns (non-overlapping). Most of us would not put too much faith in a sample size of 5. That is where we are with stock market data.

 

Imagine 5 coin tosses, results in 3 heads. "Historically" we infer that heads come up 60%, then use that damn thing to make predictions. The stock market equivalent are the historical 6.5% annual real returns and the 6% or so net profit margins.

 

In another couple of thousand years, we might have a better idea. But until then, it is best not to have strongly held views on macro stock market valuations.

 

Vinod

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It’s useful to look at this through a portfolio allocation prism. Assume a 60/40 equity split.

Ever since the GR2, interest rates have been driven artificially low. If the expected S&P nominal return is 9%, & the bond return is 3.25% - the portfolio should have earned 6.7% [0.6x9% + 0.4x3.25%]

 

Redo the calculation today.

Most would expect interest rates to rise & equity returns to fall accordingly. If the expected S&P nominal return falls to 7.5%, & the bond return is now 4.50% - the portfolio should earn 6.3% [0.6x7.5% + 0.4x4.50%]. Supposedly a bias downward as the globe comes out of the GR2? When historically, equities generally perform better when they come out of recession.

 

Mathematically, for the portfolio to maintain the 6.7% return – the S&P return has to increase by 38% [4.5/3.25] = 1.38.  Hence the lower the base bond return is - the more the S&P return needs to increase – and the more risk an investor has to take on.

 

A PM would simply churn the portfolio & invest in more risky equities. The long-term value investor would just continue to hold onto their dividend payers – with the dividend payments returning some of the original capital outlay every month; and thereby raising return on the remaining capital invested.

 

SD

 

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