With every asset from real estate to stock valuations peaking, you might be wondering where to invest in a bubble. You can feel especially fearful of a bubble if your portfolio allocation is polarised towards one market such as a technology heavy index, such as the S&P 500. This type of asset allocation can result in you being hit especially hard when boom goes to bust.
The stock market is moving fast in 2022. It has already started with a market correction and even a bear market for the Russel 2000. This could be the start of a 2-sigma equity bubble crash across multiple assets. Alternatively, valuations across stocks and real estate may also continue into a Superbubble. This is the expected scenario if interest rates are kept at all time lows. As inflation threatens to spiral out of control the Federal Reserve and Bank Of England will have to decide if they should raise interest rates. This is projected to could cause a major stock market crash of over 50%.
Alternatively, they may delay and delay until a superbubble certainly exists. When we talk about a Superbubble, we’re talking about the likes of the Japanese asset bubble. Prices reached such an extreme level that even 30 years later it has not fully recovered. Knowing where to invest in a bubble becomes an increasingly important question, not only as valuations rise but as they crash.
How Can You Protect Yourself From A Superbubble?
You might therefore be asking how you can protect yourself from a bubble. What do you invest into in the short, mid and long-term to cover all possible outcomes? You might also be considering shifting your asset allocation to protect yourself from future stock price crashes. However, many assets such as bonds have had very poor returns in recent years. This has certainly influenced my strategy for investing. I have personally been driven towards a near 90% stocks allocation, as this is where the data has driven me.
So what’s left, Gold? Dividend stocks? Cyptocurrency? Is real estate a secure and stable option? Despite potential overvaluations do we still run with tech stocks which have the potential to dominate the market into the foreseeable future. Are the untapped markets of growth we should shift to or do we stay the course with an index fund strategy. Then again, is the S&P 500 even safe anymore?
Disclaimer: This is not investing advice. You are responsible for your own investing decisions. When investing capital is at risk.
ANdrew | Mr Money Side Up
The Signals Of An Asset Bubble
There are multiple red flags of an asset bubble right now. It certainly seems like housing prices are peaking. Interest rates are damaging returns and stocks are overvalued. The “Buffett indicator,” total stock market capitalization to GDP, broke through its all-time-high 2000 record. Add to this Economists and Investors such as Jeremy Granthan, Robert Shiller, Nouriel Roubini (who all called the 2000 and 2007 bubbles) are all hedging their bets against a Superbubble.Back in 2020 I wrote an article referencing that the PE ratio for the S&P was 38 and 90% higher than the historical average of 19. They have stayed just as high since then.
The 5 Stages Of An Asset Bubble
PE ratios alone aren’t enough to simply say if we are in a bubble as valuations may catch up to the prices. There’s often more intangible symptoms and stages. Economist Hyman P. Minsky was one of the first to explain the development of financial instability and the 5 stages of a bubble. Which can be applied to stock, asset, credit or commodity bubbles. These are:
- Displacement: investors get enamoured by a new paradigm, such as an innovative new technology or interest rates that are historically low. You could say that both of these have been fundamental features of both stock and housing markets.
- Boom: Prices gain momentum as there is more media coverage and more participants enter the market and cause fear-of-missing-out (FOMO) for those that don’t.
- Euphoria: Caution is thrown to the wind as metrics and measures are used to justify relentless price rices. The greater fool theory – the idea that no matter how high prices go, there will always be a market of buyers willing to pay more. At this point valuations are reaching extreme levels.
- Profit Taking: There are individuals that actually start to get a little scared or smarter cash out. For example, there were certain banks prior to the 2008 financial crisis that actually started to reduce their exposure to bad debt.
- Panic: There is an event which pricks the bubble, prices rapidly descend as supply outpaces demand. Investors and speculators try to sell out to avoid hitting rock bottom and losing money. This pushes prices further down.
The UK Housing Market Is In A Late Stage Bubble
What about property, does real estate offer a safe haven for investors? When you look around you see bubbles everywhere. UK house prices are also in the later phases of a bubble. US house prices are equally distorted. Historically low interest rates have allowed people to borrow increasingly more against their income (Displacement). House prices have jumped £34,000 since the start of the pandemic. At a time when GDP crashes, people lost income and businesses have suffered (Boom).
Despite sky high valuations and unaffordability, people continue to rush to the market. Driven by the desire to get on the housing ladder before it slips from their grasp. Banks are now allowing people to borrow 7 times their income! Up from the usual 4 to 4.5x. There are 5% deposits accepted and 40-year mortgages now.
You could well argue that we have entered the profit-taking phase of a housing bubble. There was a 66% rise in the number of people using equity release in the first half of this year. In the U.S, cash-out refinancing (when borrowers trade an existing mortgage for a bigger one and then pocket the difference) reached the highest level since the 2008 financial crisis. It’s estimated that there is a record $9.4 trillion in tappable home equity collectively or an average of $178,000 per borrower.
Does Cryptocurrency Offers A High Growth Long-Term Investment?
Minsky also argues that during a speculative bubble the number of speculative and Ponzi borrows grows. Whilst Hedge borrowers, usually more conservative investors start lending to the Speculative and Ponzi schemes. Speculative borrowers use their income to pay the interest but not the principal. Ponzi investors simply roll over their debts. This causes a spike in risky lending and a debt bubble. However, once these debt pyramids crumble there is a credit crunch.
This is what happened with credit default swaps (CDOs) in 2008. It’s also what seems to be happening with cryptocurrency now. Did you know that 55% of the world’s top 100 banks are now buying into cryptocurrency. WIth the likes of Standard Chartered holding $380 million and Citibank – $279 million. Just two examples of high risk speculative bets becoming normalised within the banking system. To put this into context the subprime mortgage market was worth $1.2 trillion in 2008. Cryptocurrency is worth $2.3 trillion today.
From our understanding of previous bubbles, we can conclude that during the early phases of bubbles assets start to be purchased based on belief rather than thorough analysis. Where there is analysis, it uses distorted metrics to tell the story the buyer wants to see. You also see this with the cryptocurrency market. Sky-high, nonsensical valuations with no rational grounding. Investors are pouring money into any and every coin on the market. This has been creating jobs and companies overnight. Not dissimilar to the .com boom. Those that don’t buy in, are marked as naysayers who just don’t get it.
How Are Experienced Investors Approaching The Market
In Jeremy Grantham’s “Reinvesting When Terrified”, an article published in 2009 he states that investors will never time the bottom precisely and instead advises that in times of market panic (as was certainly the case in 2009) that it’s best to have a reinvestment battle plan. Otherwise it’s human nature to be “terminally paralyzed” in the midst of a massive market sell off.
Granthan has some suggestions for the potential 2022 market bubble, including: reducing exposure to US equities and emphasising value stocks of emerging markets and several cheaper developed countries such as Japan. Boosting cash reserves is also wise as are diversifying into resources that offer some financial protection such as gold and Silver. Fixed income and specialised credit may also come in handy.
Meanwhile Berkshire Hathaway’s cash on hand for the quarter ending September 30, 2021 was $69.989B, a 160.99% increase year-over-year. Suggesting that Warren Buffett is holding some cash for when the market crashes. Therefore, the consensus seems that diversification and holding back some cash are sensible strategies for where and what to invest in a bubble.
Where To Invest In A Bubble As An Everyday Investor
Conflicting information, speculation and media madness makes it difficult to know where to invest in a bubble. You don’t want to constantly flip between selling off stock, hoarding cash and then going full tilt towards stocks. In theory, it would be great to be able to time the market. In practice this just doesn’t work. Market volatility makes having an investment strategy even more essential. The consequences of trying to time the market and selling out at the bottom are desasterous! By contrast, continuing to buy and hold and stay the course throughout a bear market can make or break your portfolio.
Selecting one strategy and averaging your way through a crisis and a bear market let’s you pick up discounted assets. This is why my strategy is to continue to push money into 90% stocks and 10% REITs. Even If I invest at the peak of the market, once it crashes I will continue to buy stocks that have room to grow again. With this strategy it’s crucial to anticipate how much volatility you can stomach. Can you emotionally deal with a 20%, 40%, 50% fall in the value of your portfolio?
From this point, you can weigh up the pros and cons of moving to a more diversified portfolio with great allocations of defensive assets such as bonds. Can you take the pain in the short-term and wait for stocks to pick up? Do you have the patience and the funds to invest through the bear market?
What If You Can’t Afford To Wait For Stocks To Crash & Recover?
The standardised advice for young investors is to wait out the bear market, average down your investment and keep investing. As a young investor this is what I intend to do. Being young makes investing easy from a decision perspective. As a young investor you can strategically invest through all the crises over a 20 or even 30 year period. Even if you invest at the top of a bubble you have time for it to recover but what can you do if your investment window is 15 years or less. What should your target asset allocation be? Where should you invest prior or during a bubble?
Well, according to MFS Investments, global bonds returned 12 percent in 2008. Bonds also did well during the tech crisis, posting above 8 percent returns in 2000, 2001 and 2002. Treasury bonds and long-term bonds are argued to be safe, solid investments. This is because in crisis economics the Federal Reserve or any other Government structure is a lender of last-resort lending that props up the economy. Whilst governments, especially emerging markets can default on their debts this is unlikely. If it does, we will probably enter a deflationary spiral like in 1929, in which case putting food on the table and a roof over your head is going to be a more important issue than your stock portfolio.
What Are Robust Assets To Hold During Asset Bubbles?
Generally, gold is looked at in the same way as bonds — as a safe-haven asset where one’s money can be protected. Between 2008 and 2013 both Gold and Silver prices surged in growth whilst the S&P500 and Dow Jones bottomed out. The S&P 500 went from being able to purchase just over 2 ounces of Gold in 2007 to 0.77 ounces in 2009.
There are also sectors of stocks that hold up better in times of crisis than others. Defensive sectors, such as health care, consumer staples, telecoms, REITs and utilities, hold up better than cyclical ones. This is because the population still needs to buy things like toilet roll and toothpaste in a crisis but they might cut back on buying the latest iphone every year. Historically, large caps also do better than small caps, as the latter is considered high risk, while growth is usually hit harder than value for the same reason.
Why Balanced Portfolios May Lead To Envy But Can Support Strong Returns
The historical data shows that actually a balanced portfolio can actually be better long-term, when you take into consideration bear markets. Diversification, but not too much, can be good for portfolio returns. A well-diversified portfolio is designed to help you achieve your long-term goals as well as limit your portfolio’s downs (and ups). However, it can have its limitations and lead to feelings of disappointment. When we ask where to invest a bubble, it’s worth asking if you are willing to suffer some potential portfolio envy for a smoother investment journey.
When you hedge your bets to a more balanced portfolio you can soften your returns. As a result, you may end up with portfolio envy when the stocks surge as they have done with the S&P 500. You see how well the S&P 500 Index performed compared to balanced portfolios over certain periods but in the long-term the balanced portfolio had great long-term returns.
Whilst bonds have had a rough decade and stocks have surged, this diversify could now put those previously envious people in a strong position. Fidelity suggests the Federal Reserve is likely to begin raising interest rates in 2022, potentially raising bond yields and lowering bond prices.
How To Balance Your Asset Allocation In An Asset Bubble
Let’s be honest, diversifying into precious metals and specialised credit is not for everyone. We need sensible and easy to follow broad strategies. Were can you invest in a bubble? Well, depending on your time horizon or risk appetite you may want to opt for a less aggressive and more balanced fund. Stepping away from growth funds to more balanced funds will reduce your allocation of stocks and include additional if not multiple asset classes such as bonds and gilts. Whilst index funds are higher-risk but higher reward investments, balanced funds are usually more diversified but stable investments by comparison.
Balanced funds tend to allow adjustment towards individual goals. Selecting the best balanced fund for you depends on your stance towards growth. Are you more inclined to an aggregative, moderate or even conservative mindset? From this point you can narrow down your choices by expense ratio, historical returns, anticipated growth or the level of active vs passive management. Balancing your portfolio in this way means that you don’t have to consider where to invest in a bubble. This is because you are not polarised to either stocks or bonds for example.
To help you with your research I’ve put together a list of 5 US balanced funds and 5 UK balanced funds, depending on where you live. These are diverse funds that in theory should help with managing the fall-out of a stock market bubble. Should you want to manage that volatility, you will want to be looking for funds that can stand the test of time. This selection of 5 UK Or 5 US Funds means that you can look at investing with a responsible and trusted wealth management partner. These funds are also low cost and highly diversified meaning that you get real value for money.
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