Bubble Zone, Expensive, and Correction Musings

Amar Pandit , CFA , CFP

A friend asked me a couple of months back “Are we in a Bubble Zone?” 

I asked him to define a Bubble and why he felt so. He said he did not know much about the subject but said he was hearing a lot of noises and that held him back from investing.

First things First, let us define a “Bubble”.

Investopedia defines a bubble as an economic cycle that is characterized by the rapid escalation of market value, particularly in the price of assets. This fast inflation is followed by a quick decrease in value, or a contraction, that is sometimes referred to as a crash or a bubble burst. 

Now here comes the best part. Investopedia says typically a bubble is created by a surge in asset prices that is driven by exuberant market behaviour. Read this line again as the answer to the question lies in this line. Exuberant Market Behaviour are the 3 words to remember.

Now think about the last 2-3 bubbles that you have come across. The last 2 would be the phase from 2005-2007 (that led to the global financial crisis) and the 1999 -2000 dot com bubble (that led to the dot com bust in 2001). 

What do you recollect about these 2 events? Time travel into 1999 and 2007 and what was the general feeling around. What did you experience at that point of time?

We saw irrational exuberance all around us. Everyone had started to speak about internet stocks and how they were making easy money. Satish had shared a cartoon from New York Times (cannot seem to find it now) which showed 2 people with bowls. One was holding a Bowl with BEG written on it and another had BEG.COM written on it. The one with BEG was just holding the bowl empty while BEG.COM had millions of dollars pouring in and a long line of people wanting to invest. This might seem funny to you now but well we have all lived through this.

Look at the scenario today.

Forget Irrational Exuberance. There is no sign of even Exuberance anywhere. None that I see. In fact, there has been a Wall of Worry. First around COVID-19 and the fact the markets were going down and NOW because the markets are going up. The only thing constant has been the WORRY. So, the answer to the question “Are we in a Bubble?” is a resounding NO. On the other hand, are we expensive? Now that is an entirely different question.

The answer might seem evident “Yes, if you compare to historic valuations of the markets” but I could give you very different arguments for Yes and No, but the reality is it truly does not matter. 

What matters is whether you are investing according to what your goals require you to, whether you have a plan to act if the markets go up or down, whether you know how to manage your emotions (and not let your amygdala take over), and whether you let compounding do its job. 

One thing to remember is that the supply of companies of a certain size in our stock market (versus the US where you see Airbnb, Uber, Spotify and now Coinbase getting listed at $100 billion) is very limited or rather non-existent. Thus, the same companies will continue to attract a lot of foreign capital, which then makes them even more expensive. So, our stock markets (especially the large cap and stock market index stocks) are likely to be expensive as more capital comes in (compared to historical averages). 

A key point to be understood is that a correction can happen anytime whether the market is overvalued, rightly valued or undervalued. However, there is a difference between a Correction and a Crash. Corrections are normal and happen all the time. Someone across the globe farts and the markets can correct. Every equity investor should be or quickly get as comfortable with corrections as they are with changing weather. This is in fact a necessary condition to become a successful equity investor. Crashes on the other hand happen once in 7-10 years or more and when they do, you should be ready with a plan as these are few times in our investing lifetimes to earn abnormal returns. I will be sharing a plan and an Algorithm for this but over the next several weeks, I want to touch upon the different asset classes and my perspective on each one of them from a futuristic perspective.

I will be doing a post each (or more) on Debt = Death, Gold = Old Fax Machine (This phrase of an old fax machine was mentioned by Tim Denning), Equity, Cash, and Crypto.

I end this post with 3 powerful quotes that I see playing all the time.

  1. The first one is by Nick Murray and one of my favourites “Permanent Loss in a broadly diversified portfolio of quality equities held for the long term is a MYTH. That in fact when permanent loss occurs, it is always a human achievement, of which the equity market itself remains incapable.
    This can be seen in the historical data of the last 40 years. The markets have delivered double digit returns but have investors got it.
  2. The next one is by Peter Lynch “Far more money has been lost by investors trying to anticipate corrections, than lost in corrections themselves.” This has been true of the past and has been perfectly in play the last 12 months too. Yet again a human achievement.
  3. A Nick Murray quote once again – “All Successful investing is Goal Focused and Planning Driven. All Failed Investing is Market Focused and Event Driven.” This one too has been in play for the last 14 months like it is in the past.

Think about it.

I would love to hear your thoughts.


P.S. Read one of my previous Posts written on June 30, 2020 – The popular word “Correction” needs an upgrade.