We live in an age of bubbles. As central bankers cut interest rates to the bone and politicians pump out trillions of dollars in stimulus, asset prices are blowing up everywhere.
US tech stocks, Bitcoin, bonds, clean energy stocks and emerging markets are just some of those assets that have flown over the past pandemic-afflicted year.
If vaccines liberate the world from lockdowns and people start spending their built-up savings, current exuberance could prove justified. However, if mutant Covid strains prove resistant, sentiment could plunge along with stock markets and other assets.
Adrian Lowcock, head of personal investing at investment platform Willis Owen, says all bubbles tend to follow the same pattern. “First comes media interest, then a wave of investors jumping on the bandwagon for fear of missing out, and finally the crash.”
The trading frenzy sparked by the Reddit WallStreetBets forum over ailing US video games retailer GameStop suggests that pattern is playing out, but Mr Lowcock cautions: “Bubbles are easy to see in hindsight, but difficult to call at the time.”
So where are the biggest bubbles right now?
If the US Federal Reserve and other central bankers hadn't rushed to the rescue last March, Covid-19 would have triggered a massive stock market crash and the carnage would have persisted to this day.
Instead, the MSCI World Index ended the year 16.5 per cent higher, with the US rising 21.37 per cent.
Stimulus is propping up equities and should push them even higher if US President Joe Biden drives through his $1.9 trillion American Rescue Plan.
The Fed and other central bankers are keen to hold interest rates at today’s low levels and this should drive a "strong recovery" in corporate earnings both this year and next, Toby Sturgeon, global head of fiduciary investment services at Zedra, says.
He thinks shares can climb higher, despite risks such as a resurgent virus and today’s “overly bullish” sentiment. “Household finances are in good shape as monetary and fiscal injections will leave households with cash to spend on eating out, travel and holidays once restrictions are removed.”
Stocks look expensive by historical standards, but not dangerously so, says Mark Haefele, chief investment officer for global wealth management at UBS. "We see pockets of speculation, but the broader equity market is not in a bubble.”
However, Fawad Razaqzada, market analyst at ThinkMarkets.com, says the big threat is inflation, which could make a comeback due to pent-up demand, high government spending, loose monetary conditions and rising oil prices. "If monetary conditions tighten and interest rates rise, stocks could drop back from today's all-time highs."
Our view: Politicians and central bankers are back-stopping share prices, and investors know it. This is giving them the confidence to chase equities higher, with returns on cash and bonds so low.
The longer term worry is inflation. If that sparks into life, then all bets are off.
Tesla and big tech
US tech titans Apple, Amazon, Microsoft and Google-owner Alphabet have conquered the world and made investors fortunes.
Along with Facebook, they accounted for more than half of the returns on the US S&P 500 Index last year.
Nicholas Hyett, equity analyst at Hargreaves Lansdown, says they merit their trillion-dollar-plus valuations. “Microsoft is a quality company, Alphabet remains a mind-boggling cash machine, and Apple is enjoying rocket-fuelled sales of the iPhone 12, as well as Macbooks and iPads as the world shifts to working from home.”
The big concern is that politicians will fight back against big tech dominance, with higher taxes and anti-trust regulations.
Electric car maker Tesla is in a bubble all of its own, its share price rising fivefold to $850 over the past 12 months, making founder Elon Musk the world’s richest man. This leaves it valued at a ridiculous 1,327 times earnings, against 35.6 for the S&P 500 as a whole.
Mr Lowcock says Tesla has been in bubble territory for years, as investors back its potential rather than its current strength. “It could go on to justify its lofty share price, but the fact it is so overvalued rings alarm bells.”
Matt Weller, global head of market research at GAIN Capital, says: "Tesla is priced for perfection, so any signs that other car makers are cutting into its dominance could lead to a sharp reversal in the stock.”
Clean energy stocks may be overvalued after a storming 2020, catching out the growing number of private investors who are putting their money into environmental, social and governance (ESG) investments.
Our view: The big money has been made from big tech. These brilliant businesses cannot be written off, but don't overdo your exposure. Beware the ESG bubble, too.
There are bubbles, then there is Bitcoin. The price has surged from around $7,000 to more than $48,000 in the past year, turning early adopters into multi-millionaires.
Elon Musk is behind the latest jump after Tesla bought $1.5 billion of the crypto, while MasterCard and Twitter have since declared their interest. Simon Peters, crypto-asset analyst at trading platform eToro, expects other major firms to follow. “Bitcoin payments increasingly make sense for businesses that conduct nearly all their sales online.”
While Bitcoin is up 377 per cent over the past year, fellow crypto Ethereum is up 727 per cent to around $1,800. Mr Peters says Ethereum is becoming more decentralised and secure, and could have further to go. “We expect Ethereum to cross through the $2,000 mark in short order before reaching $2,500 by the end of the year.”
Mr Haefele warns that cryptos are being driven by speculation rather than fundamentals. "Investors should exercise extreme caution."
Our view: Bitcoin is either the biggest bubble around or a breakthrough technology that will transform the world in ways we don't yet understand. Either way, it's a gamble, so do not invest money you cannot afford to lose.
Gold thrives in bad times and the price hit an all-time high of $2,084 last August, but has since trailed down to around $1,800.
Mr Weller says this historical store of value should be doing better given the pandemic, a weak US dollar and massive stimulus. Low interest rates should also have boosted gold, by hitting the appeal of rival safe havens such as cash and bonds.
Mr Razaqzada says gold is struggling as investors take a “risk-on” approach, assuming that vaccines will drive a recovery.
Our view: If the recovery stalls, gold could be back. If we are heading for another "roaring twenties", as the optimists claim, it may lose its shine. Every portfolio should have some exposure, but no more than 5 or 10 per cent.
The pandemic may have originated in China, but you wouldn't know it by looking at the country’s stock market.
The MSCI China index grew a thumping 29.67 per cent last year, making it the best performing major market, and is up another 7.36 per cent so far this year.
China was the only major economy to expand in 2020 as its gross domestic product grew by 2.3 per cent. The future also looks bright, with middle-class consumers expected to double to more than 600 million over the next decade or so.
China has benefited from being first into the pandemic, and first out, Carly Moorhouse, fund research analyst at Quilter Cheviot Thomas, says. “It is the world’s second-largest economy, most populous country and home to some of today's most successful and innovative companies.”
Our view: Every investor should have some exposure to China as it celebrates the Year of the Ox.
The bond market has been in a bubble for more than 30 years. Ever since policymakers started slashing interest rates in the 1980s, bond yields have been falling while prices have risen.
Prices are now so "elevated" that a quarter of all global bonds trade at negative interest rates, Mr Haefele says. If inflation takes off and rates rise, bonds could struggle as they pay a fixed rate of interest and will become less attractive as cash offers more.
However, Mr Haefele thinks that is unlikely to happen as policymakers have chosen to make safe assets like bonds expensive to encourage investors to buy riskier assets like equities. “This bond bubble is unlikely to pop, given that it is supported by policymakers themselves."
Our view: Low interest rates and fiscal stimulus will protect the bond bubble for now. However, a sudden rise in inflation could burst it, with nasty consequences.