Equity markets gave back much of this year’s gains this week before stabilizing, as investors globally considered the prospect of asset price bubbles and a potentially faltering recovery. US economic growth for last quarter came in under expectations, solidifying the significant loss of GDP for 2020. Worryingly, consumer spending appears to be moderating, the linchpin of the US economy. The labor market showed some small signs of relief, with declining levels of initial jobless claims and continuing claims also moving lower. However, initial claims remain over four times higher than before the pandemic, spurring the Federal Reserve to reiterate their zero-interest rate policy and asset purchases program for the foreseeable future.
The traditional warning signs of a bubble continue to flash bright red, and investors are trying to avoid relying on the adage of “this time is different” with the positive interest rate environment and imminent economic rebound bolstering their confidence. At a minimum, investors can feel relatively certain that stocks will outperform bonds over the coming years, with rates at record lows and corporate credit spreads offering little extra return for additional risk. The evidence of exuberance continues to mount, however, with several indicators sounding alarms: cash levels for institutional managers are near record lows, while they acknowledge the risk-taking in portfolios are extremely elevated, as companies not generating profits are at record valuations, and investor flows into equities and traditional metrics such as the price-to-earnings ratio sit near past peaks. Perhaps the most unsettling aspect of all are the stories dominating headlines of retail, day-trading “investors” who are using online social platforms and free trades to make significant bets on stocks. Driven by the work-from-home trend, free time on their hands, and stimulus payments, these hordes of investor armies have made news by purchasing en masse beaten down and heavily shorted stocks which fundamentally have little or no value. Many of the companies targeted are near bankruptcy with doubtful prospects of a turnaround, but the day traders’ reckless buying has caused share prices to surge hundreds of times over, causing shutdowns at major brokerage firms on heavy volumes. Similar to a Ponzi scheme, this type of speculation relies almost entirely on one fool selling to an even greater fool at a higher price, with the last investor likely to lose the majority of their investment. This unhealthy mania cannot last indefinitely, and is reminiscent of the dotcom bubble, where companies with little more than a website and a catchy name saw their stock go to record highs. Fortunately this time around, the money involved is not very significant in terms of the size of the overall markets, and should not create systemic risk, in our view. However, we are keeping a sharp eye on this trend and other indicators to limit exposure to these types of portfolio risk.
At this time, we continue to believe that the “buy-the-dip” mentality in select areas of the market remains attractive given the easy monetary backdrop and stimulus in the pipeline. The drop in recent days is likely a small opportunity to buy equities at a slight discount, though we think greater dips will be available to make more significant purchases. Despite all the positive factors leading to the dramatic rise in equities over the past several months, the prospect of a volatility shock seems highly probable in our view. To that end, we are remaining relatively neutral, with cash on hand available to make purchases when opportunities arise. As always, we continue to remain extremely focused on monitoring unfolding market dynamics and reacting only when appropriate. Please feel free to call our office with any questions you may have.