With the Dow and the S&P 500 reaching their all time highs with the rest of the economy still suffering from a bit of a hangover, one has to be wondering what the hell is really going on! All we hear from Washington is that the economy is struggling, it contracted in the last quarter of 2012 and something about sequestration. On the news, whether it is CNN or Fox, we hear about the same things. So how exactly did the stock market end up exactly where it was before this mess happened? Is it possible that we’ve got yet another bubble forming right under our noses?
First, let’s go over what a bubble actually is. If we go check out Investopedia, we can see that a bubble is “an economic cycle characterized by a rapid expansion followed by a contraction.” Basically, some part of the market, whether it is tech stocks or real estate, grows way faster than it should, getting bigger and more overvalued than it should. Eventually, the market steps in and people begin to sell, fast, and the bubble bursts. We’ve seen this throughout history, with examples occurring all over the place. What’s happening is really simple: humans get super excited about something, everyone wants it and then, all of a sudden, it’s done. Remember beanie babies? Or ferbies? People went nuts for those things. They were toys but people were purchasing them with the intent to make an easy buck, turning them around and selling them to whomever would buy it. In the lead up to the financial crisis, a lot of stuff like that happened only on a much, much bigger scale.
The market correction for the financial crisis (aka, telling the guy with the ferbies that you’re not buying) was swift and painful. The stock market dropped 45% in about 6 months, costing trillions of dollars. Some estimates say it was a $7 trillion loss, some go as high as $11 trillion. Either way, it was a huge loss. Since the market bottomed out on March 6, 2009, we’ve seen a pretty big jump in the equities market. It’s jumped up 111% in the time since then, making back everything that was lost and then some. But the economy was dragging throughout the entire period the market was going up. Government bonds are super low, the Fed is pumping money into the economy to try to jump start it, mortgage rates are low, everything is low! But the stock market grew by 111%. How the hell did this happen?
Honestly, I think the answer is pretty simple. Most people, institutions, businesses, retirement funds, etc, don’t want their money to languish away in the low interest prison of savings accounts or US bonds. Yeah, people are still going to put their money there but why? You’re barely getting a return! You’re definitely going to lose money once you take inflation into account. So people put their money into companies. They saw that after 2009, most companies had cut down on debt and personnel and were running lean, profitable machines. Sure the economy was only so so and barely growing but the truth is, a lot of companies were still profitable. Money poured into equities because they were the only viable option for getting an actual return.
And now here we are. Markets have hit an all time high and some people are saying that they can only go higher. While that’s not entirely false (the markets will always go up in the long, long run), I think it may be time to hold back on that big investments. This may not be a bubble right now but it is definitely starting to look like it could be one.
You’re probably wondering how you could ever spot a bubble and what you could do. Well, that’s the bad news. You’ve read everything I just wrote and realized that in general, if there’s a bubble, it’s going to burst and it’s going to suck. So here’s what you can do: Don’t panic. The worst thing you can do is to panic sell everything you’ve got. A lot of people jumped out of the market in January and February 2009. They stuck in it a while but ultimately, they just handle the stress of watching their portfolio drop every day. When they eventually bought back in, they purchased the same stocks, the same mutual funds, as they had before at the same price they sold it at or a higher price. Panic selling is one of the worst things you can do.
Let’s face it, the market is going to go down eventually. It’s also going to go back up eventually. The stock market drop in 2008 was one of the worst in history. Every major recession of the past 50 years has had a huge drop like that and each time, the market fights and claws its way back. So whether we are in a bubble or not, keep your cool and don’t panic!
*DISCLAIMER: Please remember, I’m not an investment professional, CPA, CFA, or JD. Nothing I say should be construed as legal or financial advice. Please, always consult with a licensed professional when it comes to legal or financial matters.