Reasons Why This Stock Market Bubble Will Continue to Grow
Stock-Markets / Stock Markets 2010 Jan 10, 2010 - 05:01 PM GMTBy: Q1_Publishing
Rallies and bubbles tend to last far longer and grow much larger than most anyone expects.
Given what has happened in the past two years and the way things are starting out this year, there’s no reason to expect this time around to be any different.
The biggest headlines of the week tell the complete story though. High-profile views on the emerging China Bubble and revealing stories on what most investors are doing with their money now reveal a lot about where the market’s next move is likely to be. As usual, it will likely surprise more folks than not.
3 Reasons the Market Rally Will Continue
As we’ve been over before, the most important driver behind this rally has been cheap money.
Periods of cheap money policy - low interest rates and sharp increases in money supply - have always resulted in bubbles.
The reason is because cheap money always finds a home. As long as traders can borrow at 0% and buy anything that’s going up and investors are frustrated with less than 1% annual yields in money markets, money will flow to assets classes which offer greater return.
If history is any evidence, the longer the period of cheap money lasts, the longer resulting bubble will last. And, of course, the bigger the eventual price to pay when the party is over.
For the time being however, everything looks good for the current bubble to keep growing larger (ironically, it’s usually a sign it’s coming to an end when we quit calling it a “rally” or a “bubble”).
The Fed is not hiking rates anytime soon. If it does, it’s not going to be by much. And the free money party will continue.
In addition to that, here are three reasons, which dominated the mainstream headlines this week, the rally could last quite a while longer.
“The Herd” Still Hugs the Sidelines
Since the rally began, there have been very few true believers. Like generals who tend to fight the last war, investors fail to adjust to what the market gives them.
This time around has been no different. Since the rally began, most investors failed to take what the market gave them and passed up on the 2009 rally. As we noted a few weeks ago, the hottest investment of 2009 was bonds.
According to TrimTabs, a firm which tracks where investors are putting money to work or taking it off the table, most investors jumped headlong into bond and hybrid funds (funds that invest in both stocks and bonds) last year. The “conservative” funds attracted $592 billion in capital last year.
Meanwhile, for only the third time in the past 15 years, investors pulled more money out of stock funds than they put in. TrimTabs found that investors pulled out $14 billion last year. The only other times that happened recently was in 2008 and 2002 (Note: two of the best times to buy).
The Associated Press summed it up best this week when it reported, “After being key players in bull runs of the past, small-time investors have not only stopped buying, they're selling.”
One of the clearest signs of a bubble is when everyone is piling in. During the heights of bubbles you’ll see news stories of teenaged “trading wizards” and you’ll get tips from people who have never invested and shouldn’t be investing. That still hasn’t happened yet. But if history is any indication, it will.
Jim Chanos on China Bubble
It’s not just the herd falling back in love with stocks or another asset class though. There’s also the media bias.
For example, Jim Chanos reiterated his bearishness on China has all of a sudden become big news.
Chanos first burst into the headlines when he raised red flags about Enron’s unheralded “success.” We agreed with him during the short-lived “Obama Rally” from a year ago and profited alongside him as mini-bubbles in for-profit education and infrastructure stocks burst.
Overall, his track record is a strong one.
Now though, Chanos has turned his attention to China.
The China miracle has been a divisive one for many investors. We all know the boom in China has been fueled by government spending, cheap money, and it’s just like the rest of the world – only on a much bigger scale.
Frankly, only time will tell if and when the China bubble will burst. The important thing here is that Chanos has been getting so much attention.
You see, it’s not just CNBC and The Wall Street Journal giving Chanos coverage this time around. It’s now mainstream.
The New York Times has featured Chanos views on China and the big exposure has come from Yahoo’s main page. The site which gets 60 million visitors per day and usually features personal stories like “Celebrity Family Lookalikes” (really, that is the featured article as I write). Over the weekend, however, it featured short-seller Chanos.
When we’re truly in a euphoric bubble, investors like Chanos will not get any exposure. Their views will seem “antiquated” because they “just don’t get it.”
Remember when Q1 Publishing friend and famed value investor David Dreman was “fired” in early 2009 for buying stocks? Well, the same thing will happen to short-sellers like Chanos when the bubble really hits.
Sense of Urgency and a New Paradigm
That brings us to the final reasons the bubble could get blown a lot bigger than it is now.
All bubbles are marked by a euphoric period when almost all investors are drawn in. It’s when fear and greed, the two most powerful market forces, are working together.
Greed brings many investors in. Fear of missing out brings in the rest.
Also, while everyone is bidding up the prices of a select group of assets, you’ll see them start to rationalize it all. Think about “price-to-eyeballs” ratios and how “house prices only go up.”
These are new paradigms which will dominate the bubble. They’ll be strong enough to foster the get-in-now-or-you’ll-never-get-in boom right before the bust.
At this point, there is still no true sense of urgency.
Are you worried the Dow is going up 30% next year and you’ll miss out on it?
But when we do see it, we’ll know the end is near.
The Market’s Next Move
In the end, there’s no way to predict exactly when this bubble will end.
But sticking to the historical evidence which correlates giant bubbles and the Fed’s cheap money policies, it’s likely still too early to call an end to this one.
The Fed’s urgent cheap money responses to temporary panics in 1997 and 1998 preceded the dot-com bubble. A couple years of cheap money preceded the housing bubble. This time around, cheap money policies have been in effect for longer and the money printing has been greater than both of those. The rational person would naturally expect the resulting bubble to be bigger and last even longer.
There’s a lot of anecdotal evidence the rally isn’t over and it looks like it’s on its way to becoming a full blown bubble. And just like the rally has touched everything, we expect the bubble to do the same with the divide merely being between the winners and the big winners.
In the next Prosperity Dispatch (sign up here – it’s FREE) we’ll look at one asset class that’s been almost completely forgotten and will leap ahead as the rally-in-everything continues. Best of all, when it doesn’t go up, it soars. Last time it looked this bleak, it soared more than 800% in a matter of days.
Good investing,
Andrew Mickey
Chief Investment Strategist, Q1 Publishing
Disclosure: Author currently holds a long position in Silvercorp Metals (SVM), physical silver, and no position in any of the other companies mentioned.
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