What is an Economic Bubble?
An economic bubble is an economic situation where assets in the marketplace escalate rapidly at an abnormal rate.
Often, the rapid escalation of market value is followed by a market crash, this is often referred to as a “bubble burst”.
Market bubbles come in cycles, and I believe that we are currently living in one.
Let’s go back in history a little and remind ourselves past “bubble bursts”.
1. Dot-Com Bubble
The dot-com bubble took place in 1995 where large numbers of technology-based companies emerged, and investors were pouring money into these startup companies.
With an abundance of equity in the market, the source of funding became cheap for all these emerging tech companies.
By 2001, markets were saturated with technology-based companies, and investors began to panic because some companies had zero value. This caused more than 40% of tech startups to shut down and millions of dollars to evaporate.
2. US Housing Bubble
The US housing bubble was a real estate bubble that caused the housing market to collapse due to mortgage defaults.
In 2000, anyone in the neighborhood could easily purchase a home with mortgage due to low interest rates and loose credit checks. People took advantage of this.
A lot of people made money through the real estate boom but, large number of homeowners or businesses were not capable of repaying their mortgage.
When interest rate went up, the value of houses nosedived, and millions of people defaulted on their mortgage loan. This directly caused millions of dollars in the housing market to evaporate.
How is the COVID-19 crisis different from the past?
Currently, we are living in a health crisis, which is affecting our economy progression. Lockdowns imposed on countries all over the world is the direct reason to why our economy is suffering.
On the bright side, governments are pouring trillions of dollars to bail out companies (such as airlines, and retailers). It seems like we are living in a recession, but the stock market is booming.
So, what is the problem?
Hyper-inflation risk is a problem that arises when the government is pumping so much money into the system.
In 2008 and 2009, the government took the same approach of stimulating the economy, printing huge amounts of money to bail out companies. The result? It caused intense volatility in the exchange rate market and hyper-inflation.
How big is the bubble now?
As governments are stacking on debt, the bubble is growing every day. With trillions of dollars in global debt, will the government be able to repay debt holders?
To give it some context, the amount of global debt is equivalent to $100 dollar stacked-up, reaching the surface of the sun, and back to Earth. That’s insane.
If there is a day where the government is unable to repay their debt, this massive debt bubble will burst.
What should investors be careful of?
- Investing too much in the stock market
- Investing too much in government securities (AKA treasury bills, bonds)
- Investing too much in industries that are affected by the lockdown (AKA the tourism, and retail industry).
How can you limit your downside risk?
- Hold abundant liquid assets (AKA cash, cash equivalents, redeemable bonds)
- Invest in Ethereum (From my study of Bitcoin and Ethereum, I found that Ethereum is an excellent diversification tool during recessionary periods because it has a low correlation with market movements).
- Similarly, Mariana et al.’s (2021) study found the same phenomenon. If you are interested in both research papers, click here for more.
- Invest in companies that are not heavily affected by the pandemic (AKA financial services, healthcare, utilities, insurance, pension firms).
What is my take?
“I believe that the bubble will not burst” because of the increasing emergence of vaccines and the vaccine’s high success rate.
However, the longer COVID-19 takes to ease, governments will have to continue to pump money into the system. Note that this will increase the probability of the bubble bursting.
Currently, there is an upward trend that our market is recovering and I think that stock market prices in the US will continue to rise in 2021 Q3-Q4 while sustaining an upward trend over the next 2 years.
On the other hand, if COVID cases do not ease, I believe that the bubble will burst in 2022 Q2-Q3 because governments will be overloaded with debt and investors will be suspicious about the creditworthiness of government securities.
When a large group of investors lose trust in the government, it can cause a domino effect. This will lead to global panic and cause all asset prices to nosedive.
From the current news and media, we often only see the optimistic side of our economy recovering. I believe that investors should always prepare for the worse and control their risk exposure, which is why it motivated me to write this blogpost to alert investors about this economic bubble.
What is your take on the current “economic bubble?
This was purely information of my research and opinions, feel free to let me know your take down in the comments below or send me a DM (@Leinvests)