With everything from bitcoin to IPOs so perky, many have asked whether a financial bubble is underway. The answer may very well be yes, but with a nuance: Some experts think there are a series of microbubbles gurgling up rather than a single immense boom.
Strategists at JPMorgan have noted pockets of bubble-like excesses in certain areas, like renewable energy firms, crypto assets, and electric vehicles, but no major asset classes tick all the boxes. Likewise Saxo Bank’s head of equity strategy listed 40 stocks—mainly focused on biotechnology, software, media, and gaming—that have little in the way of profits and appear disconnected from economic fundamentals. And that’s to say nothing of the so-called meme stocks, like GameStop, that retail traders on Reddit have banded together to pump higher.
Are stocks in a bubble?
“I absolutely 100% believe there are parts of this market that are in a bubble,” said Stephanie Link, chief investment strategist at wealth management firm Hightower Advisors. A handful of stocks that are popular on Reddit are probably the best example, she said, but those shares are a small fraction of the overall market. Unlike the dot-com bubble in 2000, the entire tech and communications sector, which makes up almost 40% of the S&P 500 Index of large US companies, isn’t in bubble territory, she said.
“If I felt like you had a bubble going on in 38% of the market like we did in 2000, I think I’d be nervous,” Link said. She says some technology stocks may be pricey, but even those aren’t necessarily bubbly. “There are pockets and and we just don’t really play there,” she said.
Historically, most bubbles have occurred in segments of the economy but not across the entire market, said John Turner, co-author of Boom and Bust: A Global History of Financial Bubbles. This was the case in 1825 when Mexican mines, newly formed companies, and Latin American bonds were swept up in a feverish financial boom. And the good news is that these speculative frenzies don’t necessarily take the entire economy with them when they implode.
“The bursting of such bubbles is only detrimental for the economy if investors have been borrowing to invest in the bubble assets,” Turner said.
Rising Treasury yields are popping some microbubbles
And some microbubbles could be in the process of popping. Electric car maker Tesla and online exercise company Peloton, which had eye-popping rallies in 2021, are among the worst performing stocks this year in the tech-heavy Nasdaq 100 Index, dropping 12% or more. Hotel chain Marriott and Trip.com, an online Chinese travel service, have gained 11% or more.
Interest rates are seen as a key factor helping to inflate—and now deflate—the stock boom. When yields are low on bonds like ultra-safe US Treasurys, the earnings that fast growing companies are able to generate becomes more valuable. But the reverse may also happen when rates begin to increase, as they have this year. The yield on 10-year US government debt has increased to about 1.6%, up from a 150-year low of less than 1% a year ago. As the American economy picks up momentum, those yields may climb even higher, driving traders to rethink the paradigms that have been fueling the market for the past 12 months.
Investors may become more precious about parting with their capital to fund risky endeavors. Some of the most speculative stocks that have little or no earnings are dependent on being able to raise money in the equity market, said Steen Jakobsen, chief investment officer at Saxo Bank. As yields on safe fixed-income assets increase, those risky investments start to look less enticing. “Where the world sees lower and lower real yields and no alternatives, they might be attractive,” he said. “When rates go up, it’s the other side.”