I think I’ve located our next bubble, and I’m not talking about your bath.
The “bubble” I’m talking about is a run-up in the price of an asset that’s not justified by the fundamentals. Bubbles materialize when something strongly exceeds its real value to a point of ridiculousness, until it “bursts” and comes back down to earth.
Bubbles occur because every market is driven by two powerful emotions- euphoria and fear. The pendulum typically swings between the two as buyers and sellers move from a stressful, cautious state to one of greed, or craving, and then back again. Those who can control their emotions can make their fortune taking advantage of those mood swings.
But from time to time the euphoria pendulum extends farther than reasonable, when mania takes over and folks just can’t seem to live without that special something. They drive prices to silly levels, and then a little farther. Then just as quickly, the pendulum swings and that special something suddenly has a value of nuclear waste.
It’s like a game of musical chairs. Giddy buyers, champagne glass in hand, dance around the chairs to the sound of music, enjoying the moment when everything is wonderful.
Until the music stops.
Immediately the mood changes from celebration to panic as everyone scrambles for a chair. Those buyers who have experience playing the game are alert and pounce into a seat, safe from elimination.
But the inexperienced buyers, liquored up and light headed, are slow to react and late to find a seat. Their enthusiasm quickly turns to fear and then outright panic. Some of them never find a chair, and are eliminated from the game.
Bubbles have been around for centuries. In Holland in the early 1600s tulip bulbs became a status symbol for the upper class. In 1636 tulip bulbs actually traded on the stock exchanges of several Dutch cities. Many people sold their possessions, including land, to buy into the tulip market mania. At the height of the boom, a single tulip bulb traded for as much as six times the average person’s annual salary. I’m not kidding. One bulb was worth over $300,000 in today’s money. But it all came to an abrupt end just one year later when prices crashed, and that same bulb couldn’t fetch even $50.
If you think those types of bubbles don’t occur today, think again. Just a few years back when the original Dr. Pepper plant in Dublin, Texas announced it would no longer manufacture the original Dr. Pepper formula with it’s pure cane sugar (yes, you can taste the difference) people scrambled to locate the few remaining bottles. The price of Dublin Dr. Pepper quickly skyrocketed as folks just couldn’t imagine life without it. I saw six pack bottles going for over $6,000 on eBay. I thought about selling our stash, until they mysteriously disappeared from my refrigerator. But the bubble burst and within a month you could go online and find that same six pack for less than $20.
Today I see a bubble forming in professional sports. I think the pay for professional athletes is bumping up against the ridiculous.
Today I see a bubble forming in professional sports. I think the pay for professional athletes is bumping up against the ridiculous. When an athlete makes more money than the owner who’s paying them, something has to give. With all of the entertainment choices available, there will come a tipping point for increasing ticket prices and corporate sponsorships. There will eventually be a limit on how much a team is willing to pay someone to throw a football, or dunk a basketball. I can see the same thing for actors making $20 Million for four weeks of work. Studios tightening their belts to compete in today’s saturated movie and television industry may find talented, starving actors can get the job done for one-tenth the cost. But what do I know?
What I do know is that from time to time our stock market, or some part of it, experiences a bubble.
In the 1970s the price of gold kept rising, and by 1980 was worth almost ten times more than just a decade earlier. The gold bugs went nuts, but within a couple of years the precious metal lost two-thirds of its value, and many of the gold miners had lost even more.
In 2000 it was the dot.com bubble, when many traders were so excited about the internet boom they borrowed money to buy up anything that ended in .com, only to see their entire investment blow up within a matter of months. I witnessed at least a dozen companies go from over $100 a share to ZERO in less than a year.
Then there was the housing, or credit bubble of 2007. Folks with no job and a credit score that would make even a used car salesman cringe were securing million-dollar loans with no money down to buy houses they couldn’t afford to heat, much less live in. Suddenly the music stopped and not even the lenders could find a chair. Banks imploded right before our eyes. Citigroup went from $60 to $2 in a matter of days. Lehman Brothers, once a financial juggernaut, went belly up over a weekend.
How about the oil bubble of 2014 – 2015 when the price of crude dropped from $115 to $26 a barrel? Down here in the oil patch we’re still digging out of that one. Several oil companies lost over three-quarters of their value, and those were the fortunate ones. I would struggle even today to find any oil companies that have a higher market value than five years ago.
Many of my colleagues believe the next bubble will come from cryptocurrencies, or what is more commonly known as Bitcoin. The leading virtual form of currency (there are other competitors) is all the rave in financial circles and dinner parties, and its meteoric rise from $30 to $5,000- hold it, $6,500- in just two years- hold it, $7,300- might scream helium balloon bubble, but I’m not quite there yet. Eventually it may make my hit list, but until governments begin to make a serious effort to regulate it, cryptocurrencies may have more room to run. It doesn’t mean I’m ready to jump into it, but I’m not a “Never Crypto” supporter.
I do believe the next bubble in our stock market is just around the corner, and it’s in an area that’s getting very little attention in the main stream media.
I bet the next stock market bubble about to burst is complacency.
Complacency doesn’t sound very sexy, I know, but stay with me for one more minute, as it might be profitable.
Complacency can be measured in the stock market, and it’s at the lowest levels in the history of our stock market.
The “VIX”, more commonly called the “fear index”, is a volatility index created by the Chicago Board of Exchange and used by stock traders to gauge the market’s fear level. Typically, the VIX moves opposite the stock market. A higher reading means a fearful market and usually lower stock prices, while a lower reading means complacency and a bullish backdrop for stocks.
So why do I believe we are in a complacency bubble? Here are just a few reasons:
- Historically the VIX hovers around the 20 mark. Any reading above that reflects a higher anxiety level (bearish for stocks), while a reading below indicates more complacency (bullish for stocks). Over the past three years the price of the VIX has averaged around 12.
- Just nine times in the past 27 years has the VIX closed below 10. That is until 2017. In this year alone the VIX has recorded a sub-10 close on 27 separate occasions, and still counting.
- The VIX printed its lowest intraday reading of all time just three months ago at 8.84.
The stock market is playing musical chairs like we haven’t seen before.
Now before you rush to your phone and call your broker to sell all your stocks, let me give you a little more perspective. Historically, a low VIX does not automatically mean a spike is just around the corner. Anything can happen. The VIX can stay low for many more years. There is no indication just yet that complacency is near an end, so everyone can remain calm and complacent for at least a while longer. In fact, there are lots of traders who have made and continue to make a killing shorting the VIX through several popular ETFs and ETNs (the VIX itself can’t be traded) and it seems there is no end in sight for them. There are traders shorting the VXX, a fund that tries to reflect the VIX. Or they are buying the XIV, which is a fund designed for the short term to go up when the volatility of the S&P 500 goes down. The VXX has dropped from $2,000 to $35 in less than five years, while the XIV has spiked from $16 to $111 in just the past eighteen months. Those are phenomenal returns for anyone fully short the VXX or long the XIV. My guess is every one of them will keep going as long as the music keeps playing.
But the music will stop.
The way the XIV is designed, if the VIX were to double over a day or two the XIV could lose its entire value. In other words, it could go from $111 to ZERO. Poof. Gone. No way for the drunken XIV traders to get out fast enough. Think it won’t happen? Go back in history and see how many times the VIX has doubled inside a week’s time.
For those who are short the VXX, and right now that number is at record levels, what happens on the day when there is a geopolitical event that rocks our world, and they are all caught on the short side of the trade? Remember the potential loss for someone who shorts a stock is, in theory, infinite.
But you probably aren’t long the XIV or short the VXX. You are innocently rocking along enjoying the up, up, and away of the stock market over the past nine years, right?
The fact is that all things eventually revert to their mean, and one day complacency will suddenly and definitively swing to fear. Despite the gurus who will want to tell you “this time is different”, the VIX will return to its average, and quite possibly beyond. But just a reversion to its mean could double the price of the VIX. My feeling is that because it has been so long since we’ve seen 20, and many newbies to the market have never seen anything close to that type of reading, the market will be vulnerable to a possibly quick and painful panic period when buy the dip will no longer be the flavor of the month. Your stocks that have gone up steadily over the past few years could see a sudden and painful selloff as investors who don’t remember normal may drive the market into panic mode.
The trick of the trade to long term survival in the stock market is to be the first one comfortably seated in a chair when this unprecedented complacency music finally stops. My advice is while you continue to enjoy the calm, orderly, upward moving stock market that you dance next to each chair, your rear just off each seat as you pass by, ready to drop at the first sign this complacency game has come to an end.
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Musical Chairs photo1: U.S. Air Force photo/Christopher DeWitt
Musical Chairs photo2: By English: Lance Cpl. Manuel F. Guerrero [Public domain], via Wikimedia Commons
VIX Complacency Chart: https://investorplace.com/2017/05/s-p-500-complacency/#.WfzE6GiPJPZ
Musical Chairs photo3: U.S. Air Force photo/Airman Melissa Harper