Market Bubbles and the Big Picture

girls blowing bubbles, Sheaff Brock CIO looks at market "bubbles"

Market Bubbles and the Big Picture

A basic characteristic of financial bubbles, Troy Segal wrote recently in Investopedia, is the suspension of disbelief while a speculative stock price surge is happening. It’s only after a bubble has burst that it is recognized, much to investors’ chagrin. The term “bubble” itself refers to a situation in which a stock, or even the entire stock market, exceeds its fundamental value by a large margin, Segal explains.

There’s no doubt that the advent of commission-free investing apps such as Robin Hood (allowing newbie investors to purchase fractional shares with small dollar investments and essentially no barriers to entry) has resulted in increased speculative trading. In recent headlines, for example, retail investors on the Reddit online forum WallStreetBets were able to boost GameStop shares “in defiance of investing norms.”

Sheaff Brock’s Dave Gilreath, Managing Director and Chief Investment Officer, believes that while much of the speculative activity has already been “baked into” stock market value, the additional $1,400 subsidy payments might well trigger increased speculative trading.

Speculative bubbles are hardly a new phenomenon, Gilreath reminds our readers, recalling:

  • the raging U.S. stock market of the late 1920s
  • the Dotcom bubble of the 1990s
  • the U.S. housing bubble (home prices doubled from 1996 to 2006)

When the buying doesn’t stop, you get a bubble, with stock prices falling out of line with actual company value, Timothy Sykes teaches aspiring traders. Buyers believe hype and follow tips instead of using a rule-based strategy, he says. Once prices are overextended, short sellers start jumping in. Yet, as long as buyers keep buying, the short sellers get squeezed and are forced to buy to cover their orders, thus compounding the bubble effect.

That stocks are overvalued is just one of several signals that we’re in a bubble, says David Seiler of Money Morning. Yet, he adds, the odds are we’ll see more all-time highs before we see a stock market crash. Here’s why a crash is not likely to happen any time soon, Seller opines:

  • rising market optimism as more people receive COVID-19 vaccinations
  • U.S. Federal reserve policies with near-zero interest rates
  • generous lending to banks and state and local governments

2020 was a year of fear for many Americans, Jessica Menton writes in USA Today. Still, markets have since staged what she calls “a stunning turnaround,” defying a backdrop of historical job losses, bankruptcies, and shrinking corporate profits. Trillions of dollars in stimulus from the Federal Reserve and Congress propped up the economy. So, she concludes, “while the COVID-19 death toll is staggering, the stock market is telling Americans to be optimistic about 2021.”

Much is being made of the 80% gain in the S&P 500 over the last year through March 23, 2021, and equating that to a bubble. But from the mid-February 2020 pre-pandemic high, the S&P is up only 16%; surprising maybe, but hardly a bubble.

Some speculative trading over recent months might indeed be considered “bubbles,” Sheaff Brock’s Gilreath agrees, but the stock market is a forward-looking animal; for investors who manage to avoid the speculation trap, he sees more good times ahead.

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