Despite the picture I’ve chosen, it’s probably a little early to be calling the market a bubble. However, its definitely well stretched, and signs of a bubble are emerging. So let’s go through all the classic worrying signs of a hot market.
For one, we’ve got a blatant disregard for valuation. In the short-term, stocks can go as high or low as they like, but in the long-run they will always inevitably follow their sales, earnings and intrinsic valuation. When you try to value some stocks today, their current valuations imply that they’ll make so much money in the future that they’ll be the only company either; selling electric cars, running sports betting in the US, growing cannabis, selling products online, or processing cryptocurrency. In reality, there are very few companies that truly dominate their entire industry – Google, Facebook, Apple, Amazon. They achieved this through the nature of their unique business models, but they are rare, and yet today we find that many companies are being valued as though they will all be as dominant as these big tech companies, even if their business models don’t facilitate dominance – you need network effects to become as dominant as these titans. Take Tesla for example, sure its an absolute pioneer in the electric vehicles space, but there are other players in the space who will inevitably also manage to sell their cars. Yet Tesla is being valued as though it’ll absolutely dominate this entire space. It’d be like going back to 1886 and saying that the first car brand was going to be the only major car brand forever. Essentially every major car brand will eventually have their own electric vehicle offering, and I’m sure plenty of people would choose to drive a BMW or a Mercedes-Benz electric car as opposed to Tesla’s.
Another bubble sign is when any company within a particular industry (like electric cars) is given an exceptionally high valuation regardless of the actual business model. How can every electric car company dominate the industry? They simply can’t.
We’ve also got increased levels of trading. Everyday a rough percentage of a company’s total shares will be traded (bought or sold). Today we’re seeing higher and higher levels of trading activity, and that isn’t good. The more trading there is, the more fickle the investor base, and the more susceptible the stock is to a collapse. Bitcoin has around 10% of its entire value traded each day – that’s double Tesla’s 5% and 20x Apple’s 0.5%.
Another sign is when stock gains outsize gains in a company’s sales or profits. What is the rationale behind Tesla rising 700% if it’s sales rise 40%? The only explanation is that investor sentiment has changed. If the basis of your investment is on the opinions of others, you’ll be surprised how fickle that sentiment is. People forget that Bitcoin soared and then collapsed 80% as recently as 2018 – this goes to show how poor the memory and ability to learn from past mistakes is amongst investors.
The last sign is pure irrationality in the market. Elon tweets ‘use Signal’ – a messaging app – and a semiconductor company named Signal jumps 1300%. Someone starts a Reddit post about a tiny biotech stock and it soars 100% in two days – before collapsing 80% two days after that.
This market is unsustainable, everything is far beyond the historical average, and it can only be partly explained by low interest rates (when interest rates are low investors get out of bonds and into stocks to gain higher yield). So take some profits (if you aren’t going to get hit by taxes), avoid hype stocks, buy a little less than normal, hoard some cash, and wait for the inevitable correction to pounce.
