Is a Stock Market Bubble Coming?

Is a Stock Market Bubble Coming?

4 January 2018

Read this article about the stock market's rise above 25,000 for the first time today.

Here are the key paragraphs:

For many years, the market's rise was met with skepticism and hostility, earning it the widely used description as the most-hated bull rally in history. That antipathy has been seen as part of the reason for the market's durability, however, by investors who often like to cite John Templeton's maxim that bull markets "are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria."

But the market's 2017 performance convinced many observers that the bull is in a new phase. Some have warned that stocks could be in the midst of or on the cusp of a "melt-up," a rapid surge higher as investors who fear they've missed out on the rally stampede into the market. Such melt-ups are usually followed by sharp selloffs as buyers exhaust themselves.

Well-regarded value investor Jeremy Grantham, in a Wednesday note, said he sees a "possible / probable bubble" forming that could lead to a meltup in the next six months to two years that would likely be followed by a meltdown.

Here are my thoughts on the comments made in those paragraphs.

To use a phrase I have used before, politics trumps economics.

In other words, the changes President Trump has done and which one can expect he will continue to do free up the market of political controls.   As long as the economy - and therefore the market - is freed of political interference, it will continue to grow.

And as long as Trump continues peeling back regulations, the economy will continue to have new possibilities to grow, and so the stock market should rightfully respond by continuing to grow.

Will there be a bubble, and will it burst?   Certainly.   Development and stock buyers' exuberance will propel continued growth, until it overextends beyond what makes sense in the changed political climate.

What happens when the bubble bursts?   It depends on the cause of the burst.   There are two possibilities (excluding world war and comets, volcanos, or other natural calamities).

If, as noted above, the market simply over-extends beyond what makes sense, it will collapse back to a more sensible level - by first collapsing a bit below that level, and then rebounding more closely back up to that level.   If this is the case, hold on to your investments; wait it out.   Or sell some, and buy more on the downturn.

Contrarily, If the cause is political, like the passage of the Smoot-Hawley Act of 1929, then that political action - i.e., increased restrictions - means you should then sell your stocks.   The impact will be serious: a depression / recession.   In this case, buy back in at the new, reduced stock-market levels after the dive and re-stabilization of stock prices.

This would be like recognizing the implicit impossibility and impending failure of the Clinton-Bush effort (i.e., 1998-2002) to require banks to make sub-standard mortgage loans, predicting how quickly it will grow and how soon it will impact the economy, and figure out what signs to watch for that will indicate the market is close to reaching a peak, which happened in 2007, and then getting out, selling your stocks.   Then getting back into the market in 2008 or 2009, at the new re-stabilized level, and riding the new growth all over again, as we have been doing since then.

One virtual certainty about politics: when Trump leaves office, even if it is his Vice President Mike Pence who succeeds him, I doubt Trump's successor will have the brains and see the value in continuing what Trump is doing.   Barring any other possible halt to economic growth, I expect it at least to slow down once Trump leaves office.   Watch out for the next President's uttering of some phrase like, "Well, President Trump overdid it a bit."   That is your cue of what the next President's impact will be.   If his comments are negative, expect a downturn.

The U.S. economy soared under President Calvin Coolidge, who said, "That government governs best that governs least," and he did so.   The Roaring Twenties was the result.   It was his successor, the also-Republican President Herbert Hoover, who was responsible for the Smoot-Hawley Act.   And we all know the result of that:   the Great Depression, the 12 years of the socialist policies of Franklin D. Roosevelt, and World War II.   It was not until 1954 that the U.S. finally reached the same level that it had been in 1929.   A whole generation saw their fortunes lost, hopes dimmed, and lives and careers ruined, and then compounded by so many killed in WWII, and for the U.S., the Smoot-Hawley Act deserves the lion's share of the blame.

This is history from which a lessons-learned review can be immensely relevant to your well-being and prosperity.   Be aware of the facts as the future unfolds.

--   Scott Crosby

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