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Looks Like a Bubble, Love it All the Same

stock bubble

  • Equities are at their highest bubble risk, with valuations not seen since the dotcom bubble
  • Markets awash with excess liquidity will ensure that the party can continue for awhile longer at least and retail investors show no signs of losing interest in stocks 

You know it’s true love when you can look at your partner even though they’ve not shaved in days and smell like ten-day-old gym socks, and still pick no one else.

And love is what day traders appear to be communicating, because despite warning signs that equities are in a bubble, they still want in.

Like taking a bet on being the first one in on a Ponzi scheme (those are typically the ones who can get back most of their money), a recent E*Trade Financial survey found that although 75% of investors believe that the market is “fully or somewhat” in a bubble, they’re still bullish.

Bullish sentiment, according to the E*Trade Financial survey rose to 61%, a pre-pandemic level.

And despite bubble warnings for most of the past year, stocks have continued on a tear.

But the latest rally has stretched valuations to levels last seen during the dotcom era and with Treasury yields surging, the bubble warnings have grown so loud that even the most optimistic retail traders have started to take note.

Even so, the vast majority of retail investors are ignoring the bubble warnings, pushing the S&P 500 up some 83% from its pandemic lows and betting that there’s still money to be made as long as Washington keeps spending and the Fed keeps monetary policy loose.

Retail investors, who are estimated to be responsible for as much as a fifth of daily trading volume, have consistently bought where professional investors have shied away, making early bets on stocks including airlines and cruise operators, believing that they will benefit the most from a return to normal economic activity.

According to data from VandaTrack, retail investors have plowed in an average of US$1.2 billion into stocks daily in the past 12 months at a pace that shows no signs of abating.

Come this 4th of July, the conversation around the barbecue pit (where available) is just as likely to be about stocks (or stonks if you like) as it is to be about football, with a approximately 40% of households owning equities, according to a JPMorgan Chase estimate.

But whether retail investors can pick up the slack if the so-called “smart money” pulls out, is less clear and will be tested if there’s a meaningful pullback.

With interest rates continuing to stay low and Treasury yields settling somewhat, and the Fed pledging to maintain loose monetary policy and the Biden administration showing no signs of losing its appetite to spend, it’s less clear how markets would correct.

For starters, if markets were to drop sharply, any prolonged malaise would almost certainly be met with Fed intervention, especially if more households than ever own stocks.

What could be a problem is when retail investors start cashing out their stock holdings because of financial difficulties in the real economy, it’s then that “diamond hands” could really be tested.

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© Copyright of Novum Global Consultancy Pte Ltd {2020, 2021}. All rights reserved.

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