• Pierre Fournier

Are we in a "Stock Market Bubble"?

By Professor Pierre Fournier

It's rarely clear in real-time if we're in a stock market bubble. Looking at the S&P 500 as a whole, there is currently substantial evidence of a stock market bubble.

After a dramatic rebound from the coronavirus crash of March 2020, benchmark equity indices have toppled a series of record highs in the opening months of 2021. Bitcoin, the most speculative bet of them all, has raced to new extremes. Popular stocks like Tesla continue to defy efforts at sober valuation. Investors are under the misplaced impression that risk in markets "has simply vanished". Timing the end of this is hard.

Market conditions look alarming

With markets floating on an unprecedented wave of monetary fiscal support and lending money to the Government of Canada for 10 years earns you only 1.60 percent per year help to sustain that the rise in the stock markets could persist for some time.

Common features include low-interest rates, stock valuations that tower over earnings, runaway retail trading, and rapid accelerations in equity gains. On all these points, current market conditions look alarming.

But rallies could just be getting started if interest rates remain low, and fund managers feel pressure to hop on the bandwagon. Starting in the second half of last year, the economy rebounded and continues to show improvement. The rapid development of vaccines that demonstrate an ability to provide a high degree of immunity from COVID-19 is likely playing a significant role. The more widespread the administration of vaccines, the better the result is likely to be for the economy.

Speculation and bubble

During this run higher in markets, a number of fresh bubble concerns have emerged, particularly among stocks favoured by retail investors.

Earlier this year, shares of beleaguered companies, including GameStop Corp. and AMC Entertainment Holdings Inc., as well as former technology stalwart BlackBerry Ltd., were sent surging as a horde of retail investors piled into the names.

I have no interest in those types of speculators or their investment targets, instead preferring stable companies with long-term investors aligned with the corporate goal rather than the quick-money crowd.

Those people who are trading are not investors. Let me give you the most simplistic definition of an investor: a person who owns shares and who sees the ownership of those shares as a percentage interest in a business, versus someone who owns shares and sees the shares as pieces of paper to be traded.

Some also point to the explosion in trading by inexperienced amateurs as a particular concern. These traders, seen as flighty “weak hands” by professional fund managers, intolerant of losses and quick to exit bets, have been on the ascendancy as lockdown boredom encouraged them to the commission-free trading offered by start-ups like Robinhood.

My recommendation

Given the frothiness of the current market, investors may want to approach their stock purchase decisions in a philosophical manner. There's no perfect way to insulate yourself from volatility in the stock market, and bubbles do occur from time to time. Sky-high equity market valuations will take a tumble and present significant buying opportunities. The best approach, and one of the easiest, is to buy shares in high-quality companies and hold them for the long term.

Inflation can cause pressure on the markets

According to the latest data, inflation accelerated at its fastest pace since 2008 with the U.S. Consumer Price Index spiking 4,2% from a year ago.

Inflation accelerated because the economy is recovering from the downturn of 2020 as more people are vaccinated, stimulus fuels consumer spending and businesses gear up for the recovery.

For investors, the worry is that this increase in inflation could force the Federal Reserve to change its monetary policy sooner than hoped, either by raising interest rates or tapering its billion-dollar asset purchases. That could be bad news for the stock market.

Disclaimer: This article is intended to be used and must be used for informational purposes only. It is very important to do your own analysis before making an investment based on your own personal circumstances.

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