The New York Stock Exchange in New York, on Feb. 24.Seth Wenig/The Associated Press
Sam Sivarajan is a wealth management and fintech executive with a doctorate in behavioural finance. He is also the author of Money Talks: Lessons from Canada’s Wealthiest.
“History doesn’t repeat itself, but it often rhymes,” goes a famous quote often attributed to Mark Twain. George Santayana said: “Those who cannot remember the past are condemned to repeat it.”
Those two statements are a perfect foil for the fear of missing out (FOMO) and there is no alternative (TINA) investment themes that have been driving the market.
How so?
In a low-interest-rate environment, many investors feel there is no investment alternative to stocks and real estate; and continuing reports of rising prices in these asset classes are creating fears in investors of missing out.
Today, almost all asset classes are hitting record highs. The S&P 500, despite a tough start to the year, is still almost 30 per cent higher than before the pandemic shut the economy down in the first quarter of 2020, and almost 90 per cent higher from the lows of March, 2020. Since then, we have also had a run-up in meme stocks (GameStop up more than 3,000 per cent, AMC Entertainment almost 500 per cent), in bitcoin (up almost 500 per cent), and in oil (up more than 450 per cent). Housing prices have risen by 20 per cent to 30 per cent in the past year in many Canadian markets, making Toronto more expensive than Vancouver for the first time in many years.
But dark clouds may be ahead. Mean reversion, a statistical concept, implies that things return to their trend. This is why sports dynasties (the 1980s Edmonton Oilers or the New England Patriots) or business dynasties (General Electric, Kodak) do not last. As sports teams have success, their payrolls get bigger, their ability to evolve their style gets harder and other teams get better draft picks. For businesses, share prices rise to reflect their past success, meaning that to generate the same percentage return they require higher earnings.
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Take Apple, for example. When it was a US$100-billion company, introducing a product like an iPhone that generated US$5-billion in annual sales had a big impact on the share price. As a US$1-trillion company, to have the same type of impact on share price, Apple must introduce products that can generate US$50-billion in annual sales. Simply put, mean reversion means that if the level of growth in asset prices is above trend for a period, there will be a period where the level of growth in asset prices is below trend. Seven lean years following seven fat years, if you will.
Jeremy Grantham, a U.S. money management veteran with a reputation of correctly calling stock market bubbles and crashes, has recently raised the alarm bells again. He noted that data confirm that asset prices have risen significantly above the normal trend growth and are now in superbubble territory, which suggests a reversion to the mean is coming – in other words, a painful correction to more typical growth rates. According to Mr. Grantham, we have had three superbubbles in equity markets in the past 100 years: the U.S. in 1929 and in 2000; and Japan in 1989. Plus, there were two superbubbles in housing: the U.S. in 2006 and Japan in 1989. Mr. Grantham warns that all five of these superbubbles corrected all the way back to trend, resulting in pain greater and longer than average corrections.
Today in the U.S., he believes that there is a superbubble perfect storm – in equity markets, housing and commodities. Mr. Grantham argues that the U.S. housing market is bubblier than before the Great Recession – but still not as bubbly as other markets such as Canada, Britain, Australia and China.
Markets have corrected in the past – housing, equity, commodities – all of them. Bubbles form because people believe that prices tomorrow will be higher than today. When people no longer have those beliefs, bubbles burst, and they do so rapidly. There are any number of catalysts that could trigger the popping of today’s superbubble. These include continued inflation, the long-anticipated interest-rate hikes, the conflict in Ukraine, or domestic strife (including “freedom” protests in Canada and other countries).
Remember that market prices are interconnected – across asset classes but also across geographies. Investors should also remember that the pendulum does swing back eventually, which is not a reason to panic, but it might be a reason to duck. In this context, ducking simply means investing long-term and positioning your portfolio for the bubble bursting at some point in the future.
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