"If I'd have had more time, I'd have written a shorter letter" ~Blaise Pascal
By far, the most common question we get today is about bubbles. Unfortunately, most people are not referring to the kinds of bubbles you pour into a fine crystal glass and enjoy with friends. Indeed, if Google search trends are any indicator, the public's concern over stock prices is undoubtedly great.
While we do believe that certain areas of the market have attracted extreme speculation (think GameStop and any company that Elon Musk tweets about), we need to stop and consider some of the thoughts we have espoused over the last few decades, mainly:
The public as a whole is underinvested in equities.
The amount of money on the "sidelines" is enormous.
The current interest rate environment, with "Real" rates (actual interest rates minus the rate of inflation) actually negative, indicates money should naturally flow to equity markets, and
Younger generations haven't typically participated in equities.
So, perhaps we shouldn't be too surprised to see the increase in enthusiasm in stock investing, particularly as a new generation of investors has broken down many of the barriers (real or perceived) of the stodgy old investment world through gamified investment apps such as Wealthfront, Betterment, Robinhood and a host of others.
While I hesitate to consider today's environment a "New Normal" in terms of valuations, perhaps these numbers do start to make some sense when you consider the above factors. We've long postulated that if these elements ever aligned, we could see sharply higher equity valuations, and it appears that this may finally be the case.
In a very timely fashion, my friend John Taft and his team at Baird have released two excellent and back-to-back notes on the concept of bubbles, which can be found here and here. They make a couple of extremely interesting points:
The top 5 stocks in the S&P 500, which make up just over 20% of the market cap of the index, currently trade at a P/E ratio of over 34. The next 495 trades at approximately 21.
Diversification matters: There are several areas of the market that have been subdued during the most recent rise, including utilities, energy companies, and certain international markets.
Further, they reiterate the point that trying to be "All-in" or "All-out" is a fool's game and that maintaining an appropriate balance for your particular needs is the key to a successful strategy.
More importantly, John touches on a bubble that we should be thinking about: The inarguable "Debt bubble" that we find ourselves in today. Based on current trends, it looks like the national debt (not including entitlement spending) will exceed 100% of GDP for the first time since World War II.
Looking back at the economic lessons learned exiting that war, we know that the economy can productively grow itself out of a considerable debt burden if allowed. Taft cautions, however, that putting too many restrictions on growth, such as an overall increased regulatory burden for certain industries, or attempting to legislate that growth be "inclusive," "green," or "sustainable," may serve to stifle the tremendous entrepreneurial engine that is America today. Therefore, putting the recovery at risk.
As we have discussed in our "Megatrends" sessions, there are already strong social tailwinds driving the economics behind these factors and others. It's best to let the market take over from here and let industrious American people build their way to a bright financial future!
As always- Make it a Great Day!
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