At the risk of further inflating the bubble in discussion about whether or not global equity markets are in a bubble, I think it is worth discussing the topic from a qualitative point of view. Most of the talk of bubbles is data-driven analysis focusing on things like multiples, profit margins, revenue growth, historic equity market tops, equity risk premiums, and so forth.
But having worked as a professional money manager through two market bubbles — dot-com and real estate — I can attest that qualitative signs are often more persuasive than the quantitative signs. Over the years I have identified anecdotal signs of financial excess, and I couple these signs with hard data, such as comparing current valuation levels relative to historical data, to determine if financial markets are in a bubble.
Here then, are my top anecdotal signs of a market bubble:
- Covenant creep – Here the terms for new financial securities are especially bad for buyers. In the bond market, this may mean significantly lower coupons; massively reduced call protection; no to low call premiums; an increase in the number of embedded derivatives designed to appeal to a “hot” market; and so forth. In the equity market, this can mean the issuance of shares with no to limited voting rights; a further alteration in your ability to elect board members; and so forth.
- New issue time to market massively reduced – Similar to covenant creep, above, is the reduction in the amount of time a buyer has to consider a prospective new issue, debt, or equity. At one point in the dot-com era, new billion dollar issues were being announced just shortly before the close of the financial markets and yet being priced several hours later. Clearly this is not enough time to do your proper due diligence in researching a security to fulfill your fiduciary duty.
- Stock splits actually lead to a “pop” in share price – Say you and three of your pals order a 45 centimeter pizza at a restaurant for €20. Further, you ask your waiter to please ensure that the pizza is sliced into 8 slices so each of you may have two slices of pizza. All of a sudden the waiter comes back and says, “We have a special offer on your 45 centimeter pizza: we can slice it into 16 slices, and then each of you can have four slices each. But it’s going to cost you an additional €5.” If you were a true financial pro you would likely retort, “But it’s still the same 45 centimeter piece of pizza, just sliced more.” Welcome to the world of the stock split, the most enervating of all market stupidness, in which simply slicing the same corporate pizza more ways results in a bump in stock price. If the market actually falls for this legerdemain and bumps the share price of a company up after a stock split announcement, then you are likely in a bubble.
- Art sales are front page news – Only in a bubble do the latest results of an art auction at a big house, such as Sotheby’s or Christie’s, make front page news. After all, only in a market bubble are people making such crazy money so that it becomes disposable enough to spend a fortune on a speculative asset.
- Trust us, because you’re an idiot – Market bubbles are often confusing because, on one hand, those who know their market history can see in the hard data that valuations are insane, yet on the other hand, no one seems to care. In the midst of this tug-of-war of opinion will be those who talk of your inability to recognize the unique moment of history that you are currently so privileged to experience firsthand. Or these same folks will talk of new magical paradigms that are being hatched without full acceptance by the old-timers. In other words, “trust us, because you’re an idiot” rules the day. If you feel dumb, despite your accumulated wisdom, you are likely in a bubble.
- Hubris rising – If you look at the front page of a financial industry news source and there are stories about which bespoke tailor is the most prestigious currently, or which cities are best to refuel a private plane, or why the Four Seasons in Turks and Caicos should get a new origami towel folder, you are likely in the middle of a bubble.
- Loads of new jargon – Bubbles are always accompanied by loads of new jargon usually to describe new phenomenon unique to the bubble, such as: “price-to-eyeballs,” “mortgage backed security,” or “swaption.” While you may be familiar with these terms now, there was a time when these terms led to immediate head scratching. If you find yourself with your years of financial industry experience wondering, “What is that?” then you are likely in the midst of a bubble.
- Relatives ask you crazy investment questions – When Uncle Joe asks you about whether or not swaptions are good for his retirement account, or your mom wants to know which online discount brokerage is kindest to options traders, then you are most certainly in a bubble.
- Everyone is an investment expert – This is, of course, the classic anecdotal bubble sign and is also a close corollary to your relatives asking crazy questions. It typically takes the form of your taxi driver or hairdresser offering you unsolicited investment advice. Another, more insidious form is when folks who probably don’t know about investing tell you their opinion about the current head of your nation’s central bank. Bubble? No doubt.
- Investment news leads the regular news cast – If you go to your favorite website or turn to your favorite television channel and the lead news story is consistently about new highs in financial markets, or about new companies going public then you are likely in the midst of a market bubble.
- Sales jobs are all you hear about – In the midst of the dot-com bubble many people left behind established careers to study to be stock brokers. Meanwhile, in the middle of the real estate bubble, many people also abandoned loyal companies to become realtors. If the hottest career is in selling assets, then there is a good chance that you are in a bubble.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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