A common sign of a bubble is when investors sit around the table and brag about their huge returns, without being able to explain why, or even worse, not caring why. We have seen all this before, and yet groupthink and herd mentality have a logic of their own. One thing investors do not like to confront is the thought that their returns are driven not by their astute investment moves, but rather by the market bubble. Well, like it or not we are in a new bubble.
Starting in March 1991, the economy expanded for 92 consecutive months. The reason – the Internet bubble. Recall, investors threw money at any venture whose name was followed by .com, even if it had never made a penny. Those were the years of “irrational exuberance” that precipitated an investment bubble and subsequent market crash.
In November 2001, the herd mentality started up again, and the economy expanded 120 consecutive months. By the time it reached its peak, everyone had a scheme for making money in the housing market. What was hidden from the public were the credit default swaps and other irrational investment vehicles whose real values were as difficult to determine as their names were to remember. Nevertheless, the drumbeat of groupthink continued right up until the bubble burst in December 2007.
This brings us to today. The President is beating up the media for not giving him credit for the current expansion. In reality, the expansion has lasted for 73 months, which is 67 months longer than he has been in office. Analysts continue to tell us there is no end in sight. The expansion started with a whimper in June 2009 and for most of that time ambled along like a lame duck.>
However, the Federal Reserve kept interest rates artificially low, which allowed corporations to borrow at near zero interest rates. The low-interest rates also let financial institutions that caused the Great Recession clear away bad assets on their books. It also created trillions of dollars in economic stimulus.
Now, each day the stock market is threatening to reach a new high, supposedly in response to Trump’s promise of health care reform, infrastructure spending, and massive tax cuts – none of which is likely. Yet, the market keeps on humming – 11% return in just six months. The latest rationale is that corporate earnings justify the market over-valuation, even though this is something that has happened after the fact.
The likely reason is that investors sense they are benefactors of a presidency which only cares about making money, not about the efficacy of how it is made. Hence, market deregulation is more likely than health care reform, infrastructure spending and tax cuts. Deregulation is the secret sauce that has taken the place of credit default swaps and animal spirits and herd behavior have once again been unleashed.
The Internet bubble lasted 92 months and the housing bubble lasted 120 months. During the post-World War II era, the only other expansion that exceeded the length of the current one started in 1961 and ended in 1969. It was driven by expenditures that finance the Vietnam War and Great Society programs.
So the bottom-line is that we are in a new bubble. The only thing left to figure out is, when it will burst.
Last modified: August 7, 2017