Are We in an Everything Bubble with a Risk of Declines?

by | Jun 2, 2021 | Uncategorized

Are We in an Everything Bubble with a Risk of Declines?

Asset prices have increased significantly in recent months, with everything from stocks to the home market on the rise. Even when factoring in some intra-day stock index dives, the trend is still positive.

This has led some investors and analysts to warn of asset bubbles with the risk of significant declines once investors become more risk-averse. For the average investor, is this something to be concerned about, and are we in an everything bubble today?

Federal Reserve Warns of Potential for Significant Declines

The United States Federal Reserve has warned that as asset valuations climb, there’s an increased risk of major declines.

  • The S&P 500, a major stock market benchmark, has gained 10.54% in the year so far and 44.67% when looking at data over the previous 12 months.
  • The NASDAQ Composite, another market benchmark, has gained 3.89% in the year so far and 48.73% when looking at data over the previous 12 months.
  • S. home prices increased across the board in the first quarter of 2021. In metro areas, median prices increased by 10% compared to the previous year.
  • Even non-traditional investments like cryptocurrencies have been soaring. Bitcoin, by far the largest digital currency for investment, has gained 101.73% in the year so far.

When looking at all of these markets, it would be easy to claim that they’re all bubbles. After all, growth can’t be sustained forever.

In the Federal Reserve’s May 2021 Financial Stability Report [1], the central bank identified four major vulnerabilities for the markets in 2021.

  • Asset valuations are high, but they are vulnerable because they could rapidly decline if investor risk appetite decreases. This is true of the market in any given year. When investor confidence fails, the markets decline – effectively ‘bursting’ the bubble.
  • If borrowing increases, the risk of an asset crash will likewise increase. Business debt was flat in the second half of last year and household debt is moderate in relation to income. The government has taken steps to reduce household debt delinquency with mortgage forbearance and fiscal programs.
  • Banks are well-capitalized but the Federal Reserve warns that the existing data isn’t extensive because it lacks hedge fund and other leverage fund data.
  • Money market funds, bonds, and bank loan mutual funds are at risk, even though overall domestic bank risk remains low. The Federal Reserve highlighted the fact that there was market turmoil at the onset of the Coronavirus Pandemic in 2020, suggesting that any major economic event could put funds and bonds at risk.

Why are Asset Prices Rising?

The Federal Reserve has pointed to several factors as contributing to the rise in asset prices.

  • Vaccine-related news has increased confidence in the markets. With mass vaccinations, the threat of economic disruption akin to 2020 is minimized.
  • Additional fiscal stimulus, including the $1.9 trillion American Rescue Plan Act of 2021, has had a positive impact on the markets. The Act provides financial support for businesses and households through relief programs and direct stimulus payments.
  • The Federal Reserve has injected money into the market to support it, buying up to $80 billion in treasuries and $40 billion in mortgage-backed securities each month.
  • GDP is increasing rapidly. The growth rate in the first quarter was 6.4% [2].

The Federal Reserve could reverse its quantitative easing policy (injecting money into the markets by purchasing assets) as early as next year if economic growth continues. Target interest rates could also increase beyond the 0% that the Federal Reserve has currently set.

The key will be to balance the change in policy in a way that makes sense to the market and the wider economy. We are in an everything bubble in terms of the price of assets, but these prices are well supported for as long as investors have a risk appetite. With the economy getting stronger, growth could continue for months or even beyond 2021.