Our head of asset allocation examines why, he believes, talk of a bubble in stock markets currently is premature.
Sadly, due to COVID-19, we’re all too familiar with the concept of bubbles. But so-called speculative bubbles (when investors cause a sudden spike in the share prices of certain companies, goods or currencies without paying due attention to their value) have been a feature of stock markets for centuries.
In the 1600s, prices of tulips – a flower that became synonymous with luxury and a ‘must-have’ for the gardens of the wealthy – soared as investors believed they could make large profits by buying and subsequently selling the exotic flower.
More recently, in the years prior to 2000, the dotcom, or internet bubble, saw the values of US technology stocks rise by as much as five times as investors poured money into non-profit making internet start-ups, only to see their share prices fall substantially thereafter.
Why the chat now?
Since January, certain trends have come together to cause unprecedented amounts of enthusiasm among investors. These have included record amounts of cash injections from both central banks and governments, coinciding with a period of historically low interest rates.
This positive sentiment has resulted in increased numbers of personal investors (particularly in the US) buying selective shares with a view to making a quick profit.
But such intense buying activity is typically regarded as having a negative impact on stock markets as it creates sharp fluctuations in the prices of these companies and is seen as manipulating their everyday functioning.
Recently, events on the US stock market, whereby groups have been pushing up the share price of a struggling video games retailer, GameStop*, have been causing concern, even reaching the scrutiny of the US president and the US regulatory authorities.
Given the stratospheric jump in the share price in such a short period of time, the worry is that investors will nurse sharp losses when the share price inevitably falls.
But US central bank chair, Jerome Powell, when asked to comment on the frenzied buying spree denied that the huge increase in cash into the US economy was creating a stock market bubble, adding that he thought the current policies being adopted were necessary to support weak US economic activity.
Is bubble talk premature?
While stock markets have rallied strongly since their March 2020 lows, our head of asset allocation believes it is too early to say we are in bubble territory.
For a start, we are only just emerging from a COVID-induced recession (a recession is a period of declining economic activity that lasts for several months) where unemployment is rising, and central bank aid continues to provide relief to pandemic-stricken economies.
In essence, as long as interest rates remain low and there is enough capacity in the economy to produce goods and services, we believe bubbles rarely occur when economies are coming out of recession.
But that’s not to say that roadblocks don’t lie ahead – especially if authorities decide that the economic recovery from lockdowns, which is forecast later in the year, means that all the support given to pandemic-stricken economies is no longer justifiable and needs to be withdrawn.
Remember, the value of any investment is not guaranteed. The value of investments and any income received from can go down as well as up and you may not get back as much as you had originally invested.
* For illustrative purposes only. The above information does not constitute a recommendation to buy or sell any security.