Can You Anticipate a Bubble?
Dan Ferris, financial writer for Stansberry Research, describes 7 traits of “speculative manias.” It may not be an exhaustive list, but it’s a great start to spot a financial bubble. Although you may not spot each trait before every bubble, it’s an excellent review. Let’s go over 6 of these maniacal characteristics.
Something New
Technological and financial innovations tend to fuel bubbles. Recent examples include the dot-com boom of the 1990s and the real estate disaster due to “creative” mortgage-backed securities around 2008.
Then came Bitcoin. Let’s review a few price points:
- Around $800 in December 2016.
- Around $20,000 in December 2017.
- Around $7,500 in December 2019, as of this writing.
Bitcoin is the product of technological and financial innovation. Think it was in bubble territory at $20,000?
An M&A Boom
Mergers and acquisitions (M&As) also lead to financial crises when they are overpriced. For example, CVS just recently bought health insurer Aetna for a cool $70 billion.
It wouldn’t be a problem if the buyouts weren’t grossly overpriced. Big companies are notorious for buying smaller companies with no profits, just because they’re cool or offer trendy products or services.
Pay attention and you will likely hear about more overpriced M&As in the near future. Of note: a proposed merger was recently announced between TD Ameritrade and Schwab.
A Credit Boom
There is a weird bond-market bubble, states Dan Ferris. In some countries, such as Switzerland, German and Japan, bond yields are actually negative. This means that people who buy those bonds are guaranteed to lose money if they hold bonds to maturity!
Another likely bubble is the student loan industry, which is over $1.5 trillion and has a higher delinquency rate than usual.
Toxic Index Funds
Index mutual funds are often promoted as an easy way to invest “passively” and safely in stocks. They provide instant diversification. They cannot beat the stock market returns, but they won’t trail them badly either. They also beat most “actively” managed mutual funds. So, index funds are a logical choice for many investors.
The problem is that index funds invest “blindly” in whatever companies the underlying index owns, regardless of the quality of the companies. There is no research involved, which means that index funds likely own really bad investments.
“This Time Is Different”
This expression has become a (sad) joke about economic bubbles. People thought, “This time is different” up until the 2000 dot-com debacle, the 2008 financial crisis, and every other bubble that’s come and gone. Stock valuations are sky high right now, yet investors keep investing. They are convinced that “this time is different.”
Accounting Creativity
In your practice, there isn’t much room for creative accounting. But in large companies, there are several ways to create financial reports. Some are accurate, and some are… “creative.” Many companies follow what are called GAAP standards, which stands for Generally Accepted Accounting Principles. For various reasons, companies sometimes choose to use non-GAAP accounting.
The problem is that the difference between GAAP and non-GAAP accounting is currently widening, sometimes reaching a 20% difference. When there is a lot of pressure to report favorable news to investors, accountants sometimes feel that they have to twist the facts to keep their jobs. All seasoned investors know that. But when the general public realizes what is going on, it will be a painful discovery.
When the stock market keeps going up and reaches irrationally exuberant highs, it’s hard not to follow the herd. Yet all bubbles pop eventually.
Plan accordingly.
Phil Zeltzman, DVM, DACVS
Meredith Jones, DVM
Co-Founders of Veterinary Financial Summit
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