POWELL SPEAK: “WE DO NOT KONW!?”
A few different terms are often used to describe markets that are overvalued or otherwise considered to be in a “bubble.”
1. Overheated – This is perhaps the most common term used to describe a market that is considered to be in a bubble. An overheated market is one where prices have risen to unsustainable levels and are likely to correct or crash shortly.
2. Overvalued – this term describes a market where prices have veered way above corporate earnings and revenues. The price of assets in the market are not justified by things like cash flow, PE ratios, dividends, buybacks, or other measures of company health.
3. Frothy – is used to define a market that is starting to show signs of irrational exuberance. A frothy market is one with much speculation and excitement, but not necessarily a lot of substance to support the asset values.
4. Speculative – describes a market with a lot of trading, gambling, leveraging, and investor hubris, but underlying fundamentals do not necessarily support prices. In other words, people are buying assets in the market more for the hope of immediate gratification than for any sound principles.
5. Dangerous – This term describes a market where prices have risen to unsustainable levels and are likely to correct or crash in the near future.
Did the bubble pop?
Most likely. Stocks, bonds, cryptocurrencies, SPACs, MEMEs, real estate investment trusts, and treasuries have all been clobbered. The investor’s aim in making money is to buy assets when they are undervalued and to sell them when they are overvalued.
Regrettably, there are market participants who do not have a bonafide plan. Without tried and true experience, it is not hard to get caught up in the excitement of an overheated market and make wrong decisions. When investing, it’s prudent to be aware of market conditions and have a strategy for dealing with unexpected, unwanted, and varied outcomes.
As air seeps out of the balloon, what happens? Correct, the law of gravity pulls it back down to earth. Asset prices do likewise and have been falling all year as markets revert toward their historical average valuations based on forecasted inflation.
So, when will this bear market about-face? “The Arc” paints a picture of where we were, how we got here, and what may follow. “The Arc” illustrates a timeline from the FED’s zero interest rate policy (ZIRP) into non-transitory inflation bolstered by the shock of war. Investors are being summarily squeezed by the FED’s rate-tightening trajectory that has severely maimed investors’ portfolios. Like all bad things in life, this too shall pass. Hopefully, the passing is already underway.
Tell me about the neutral rate
The Arc’s apex in the graph points to a 4.6% neutral rate next year. What is the definition of the “neutral rate” or natural rate? The neutral rate is the interest rate that neither encourages nor discourages economic growth. It is sometimes called the “natural rate of interest” because it reflects what would happen if there were no exogenous economic or political shocks.
The futures market forecasts that the neutral rate (federal funds) will reach 4.6% by February 2023. The FED relies on economic news to make decisions as markets try to predict future events. With the majority of elections now complete, investors will look to where their money can produce the best return. But where will they put their money? Stocks, commodities, real estate, treasuries, single-family homes, or other?
When will the losses end?
For those who don’t know, bear market bottoms generally occur when shareholders lose confidence. At this point, they act in haste and engage in indiscriminate selling, resulting in asset values decreasing significantly in short order (2022). Although these markets eventually rebound, it takes investors some time to regain confidence. We are deep into this bear market, but could something better be coming?
Disclosure: any views, thoughts, and opinions expressed within this communication contains subjective opinions, and do not reflect the official policy or position of 1st Discount Brokerage, Inc.
Information is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.
Any examples, outcomes, or assumptions expressed within this communication are only hypothetical illustrations and should not be utilized in real-world analytic products as they are based only on very limited and dated open-source information.
Investments involve risk and are not guaranteed. Past performance is no guarantee of future results. Securities offered through 1st Discount Brokerage, Inc., Member FINRA/SIPC. A Registered Investment Adviser.
Author of Financial Fitness: The Journey from Wall Street to Badwater 135; Public Speaker; Professional Money Manager with 1DB.com.
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