Fighting the Bubble in Bubbles
Twenty-five percent of the respondents to the latest BofA Merrill Lynch Fund Manager Survey think equity markets are overvalued. Another 13 percent “believe that ‘equity bubbles’ are the biggest tail risk markets are facing.” That’s interesting, especially since both numbers are up a lot from previous months. And it’s definitely interesting that 84 percent think bonds are overvalued.
Read the media headlines about the results, though, and they are made to sound more than just interesting. They sound positively…bubbly: “Extreme valuations: Bonds, stocks near bubble territory” (CNBC), “Bubble fears rattle fund managers” (The Telegraph), “Bubble fears just hit their highest level on record” (Business Insider), “BofA Merrill Lynch Survey Shows Concerns Over Equity, Bond Bubble” (WSJ).
Are stocks and bonds overvalued? Maybe. Ask Stan Druckenmiller, since he’s got a lot more credibility on the topic than I do. What I do know, though, is that use of the word “bubble” has gotten way out of hand -- not just in investing but in all kinds of pursuits. Yes, people should be able to make their own word choices. But "bubble" is a useful concept, and it’s a shame to see it wielded so indiscriminately that it becomes devoid of meaning. It is time to fight back against the bubble bubble.
Here’s something that all of us, except maybe University of Chicago economist Eugene Fama, can agree was a bubble:
I bring up the Nasdaq bubble because it led many people in academic finance away from Fama’s conviction that there is no such thing. What were the characteristics that convinced them? Here are five likely suspects:
- Asset prices rose very quickly.
- Asset prices became unmoored from their fundamental underpinnings. The price-earnings ratio of the Nasdaq Composite Index rose from 20 at the beginning of 1998 to more than 170 in March 2000. It rose even higher after the bubble had begun to collapse (more on that in a moment). And while it was possible to construct lottery-style explanations for why money-losing startups deserved high valuations, as hedge fund manager and former Fama student Cliff Asness wrote in his legendary 2000 rant “Bubble Logic,” it was impossible to construct any sort of justification for the stock price of an established tech giant such as Cisco Systems.
- There was an element of psychological contagion. Many of those who were dubious about tech stock valuations bought anyway, “partly through envy of others’ successes and partly through a gambler’s excitement” (the quote is from Robert Shiller’s bubble definition).
- There were feedback loops in which rising asset prices led to earnings increases that drove asset prices even higher. Money-losing startups spent their investors’ cash on things that drove up earnings at other tech companies. This became especially clear when asset prices began to fall and earnings collapsed even faster than they did -- which is why the Nasdaq’s P/E peaked near 600 in late 2001, after stock prices had already lost most of their value.
- When prices started falling, they fell very quickly.
Now there are many, many other bubble definitions out there. And this one doesn't include the crucial element -- lots and lots of debt -- that made the housing bubble’s collapse a few years after Nasdaq’s so much more devastating. But I don’t think you need debt to have a bubble. You just need debt to have a financial crisis after the bubble.
Are we in a bubble now? Well, it depends which one you’re talking about. Here’s a far-from-exhaustive rundown of a few of the bubbles the world is said to confront or have recently confronted.
The shoe bubble: High-end women’s shoes are the fastest-growing category in fashion. In offering explanations for this phenomenon, New York Times fashion editor Vanessa Friedman recently called it a “bubble” a couple of times. But she made it sound like a semirational if not indefinitely sustainable phenomenon, and it’s definitely not the kind of thing where expectations of rising shoe prices are a major driver of shoe purchases. Your investment in Jimmy Choos is safe, or at least as safe as it ever was. Especially if you store them in a ShoeBubble.
The better burger bubble: “Do you think there’s a better burger bubble?” Fortune’s Beth Kowitt asked Shake Shack founder Danny Meyer last month. “Absolutely not,” he replied. So that’s settled. In his explanation, Meyer differentiated between hamburgers, which people have liked forever, and the recent popularity of cupcakes and frozen yogurt, which he intimated had been a little bubbly.
The cupcake bubble: Journalist Dan Gross, coincidentally the author of “Pop! Why Bubbles Are Great for the Economy,” declared the existence of a cupcake bubble in 2009. The evidence: all of a sudden there were lots of cupcake shops. Now there are fewer, and by 2013 and 2014 people were declaring that the bubble had burst. So cupcakes were suddenly very popular, and now they’re less popular. There’s a perfectly good word for such a phenomenon, and it’s not bubble. Cupcakes were a fad.
All the Ivy League schools, as well as Stanford and the like, have convinced everybody that admission is worth the price of the exorbitant tuition, and so far the world has fallen for the pitch, just like everybody else fell for the housing bubble.
When Rogers goes on to explain how this will end, though, it stops sounding like a bubble. In his account, it’s not so much that a degree from Princeton or Harvard has little value as that new technologies are bringing more efficient ways of learning that will render Princeton and Harvard irrelevant. If Rogers is right, it would be a case of technological change disrupting an established way of doing things, not a bubble collapsing. I’m sympathetic to the use of the word “bubble” here because I can’t think of an obviously superior replacement. But it’s a very different phenomenon from an asset price bubble.
The carbon bubble: Also has its own Wikipedia entry, which traces its use to a couple of reports from the Carbon Tracker Initiative and a 2012 Rolling Stone article by environmentalist Bill McKibben. Wrote McKibben:
If you told Exxon or Lukoil that, in order to avoid wrecking the climate, they couldn't pump out their reserves, the value of their companies would plummet.
So certain companies’ stock prices would collapse if the world’s politicians got tough on carbon. This sounds more like political risk than a bubble, but “carbon bubble” does have a better ring to it than “carbon political risk.”
The bitcoin bubble: There is no intrinsic value to a bitcoin, in the sense that there are no earnings or precious metals or government taxing powers attached to it. So you could say it’s a bubble no matter what the price is. I subscribe to the more sympathetic view that it’s a new, potentially useful thing that people are still trying to figure out how to price relative to established currencies. But yeah, any sharp rise in bitcoin’s value is going to have bubbly elements to it.
The bond bubble: The idea here is that central banks are keeping bond prices artificially high and yields artificially low, and that yields have to rise and prices have to fall sometime. Which is all probably true, but does that make it a bubble? University of California-Berkeley economist Brad DeLong says no:
Call them extremely richly-valued. Call them low return. Call them risky for those without the option to hold them to maturity. But if you have to use the word “bubble” apply it to other things.
The private-market tech bubble: Mark Cuban, who has built a pretty fun career and life out of his windfall from the last tech bubble, declared last month that the current rush into funding companies such as Uber and Snapchat is worse than the one that made him rich. The reason it’s worse, he wrote, is that since the hot dot-coms of 2000 were all publicly traded, “investors had the liquidity to sell their stocks.” Now the hottest companies are still privately held, and that’s scary:
Because the only thing worse than a market with collapsing valuations is a market with no valuations and no liquidity. If stock in a company is worth what somebody will pay for it, what is the stock of a company worth when there is no place to sell it?
This sounds like a reason why -- if this is a bubble -- its end will be especially ugly. It's not really a case for this being a bubble, although it definitely sounds like something worth fretting about -- at least if you're part of the relatively small population of investors able to invest in these unicorns.
The risk bubble: Venture capitalist (and Uber investor) Bill Gurley has also written fretfully about the boom in high-value private financing rounds. Some of his concerns are similar to Cuban’s, but he also wrote this:
[W]e are not in a valuation bubble, as the mainstream media seems to think. We are in a risk bubble. Companies are taking on huge burn rates to justify spending the capital they are raising in these enormous financings, putting their long-term viability in jeopardy.
That is, because investors are willing to give promising young tech companies so much money, those promising young companies are pushing too hard to grow fast enough to justify their valuations. It’s a feedback loop in which high asset values are driving value-destroying behavior. Now that sounds like it could be a bubble.
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