Three candidates for the next big economic bubble

My Comments: I was here for the crash of 1987, the crash of 2000, and most recently the one in 2008-2009. I wasn’t here for the one in the 1930’s but my parents were and that probably influenced my thinking about market crashes.

Many of us think we’re overdue for another. There’s a lot of froth in the price of equities these days. Some of it might be justified. Just as the price of real estate is a function of location, location and location, the price of equities is a function of earnings, earnings, earnings.

When the next crash happens is, of course, a total unknown. But if you have money invested to help pay for your retirement, you need to be careful and as informed as possible. These words might help.

By Ryan Avant \ 16 FEB 2020 \

THREE HUNDRED years ago, the British Parliament passed what became known as the Bubble Act. At the time, the economies of north-west Europe were teeming with newly formed joint-stock companies—“bubble companies” in the parlance of the day—the best known of which was the South Sea Company. Bubble firms thrived on the near-hysterical investor enthusiasm of the moment, as they sought to lure capital into their moneymaking schemes (some more creditable than others). The Bubble Act attempted to restore order by requiring newly formed firms to have a Royal Charter. The mania nonetheless imploded spectacularly. By the end of the year the South Sea Company (ostensibly created to control trade with South America, but in reality a vehicle for financial shenanigans involving government debt) saw its stock decline in value by roughly 80%.

The crash of 1720 marked the “popping” of the first great international financial bubble. Three centuries later, investors are as susceptible to financial manias as ever, despite the hard lessons of the housing boom and bust. Economists reckon there is some rhyme and reason in the outbreak of exuberance. Bubbles usually have their origins in plausible stories about how changes in the economy could create opportunities for huge gain. The South Sea bubble occurred alongside the emergence of publicly traded, limited-liability insurance firms, and amid a fervour for the potential of trade in the Americas. Bubbly-looking markets today are built on the same foundation. In 2020 several could-be-bubbles could burst.

The first and most obvious is America’s technology boom. Over the past decade, Silicon Valley and other tech hubs produced a steady flow of startups seeking to dominate new sectors. Firms like Uber, Slack, WeWork and Airbnb married technology and new business models with promises to deliver extraordinary returns by capturing winner-take-all markets. Wealthy investors poured cash into these ventures, giving rise to the phenomenon of the “unicorn”: a privately owned startup worth at least $1bn. Such creatures were once rare, but multiplied as the frenzy continued. Now the moment of truth looms. Profits have proved more elusive and market dominance harder to achieve than promised. Share prices for firms like Uber and Slack sank steadily after their initial public offerings in 2019; other firms, like WeWork, shelved ipo plans amid growing tech scepticism. The unicorn boom, like the dotcom mania, will end up producing its share of profitable megafirms. But 2020 will bring a shake-out, and plenty of investor losses, as the pretenders find they can no longer maintain an aura of financial invincibility.

Bubbliness has also found its way into the relatively staid market for government bonds. Bonds dramatically outperformed stocks over the past year, continuing a long bull run. Demand for government debt has soared in recent years: prices for bonds have risen sharply while the interest rates governments have had to offer have tumbled. Yields on American bonds, though at historically low levels, look high in comparison with the negative rates on offer in Germany, France and Japan. Bond-buyers may be betting on slow growth and negligible inflation. Some, too, may be keen to hold safe assets amid the uncertainty associated with a global economic slowdown and a Sino-American trade war. Bonds have also been gobbled up by big institutional investors, like pension-fund managers and insurance firms, which have used currency bets to wring more yield out of government bonds paying ultra-low rates.

The long run of rising bond prices seems to have convinced investors that bond markets move in only one direction—often the sign of a bubble. A reversal in bond prices, or an unexpected adjustment in currency values, could force vulnerable bond investors to abandon their bets, leading to more market havoc. Some safe-haven bonds, like Treasuries, would probably do well in a shake-out. But others, like Italy, which can now borrow long-term at a rate of less than 1%, may be less fortunate.

The greatest pessimists point to a third bubble candidate: asset prices generally. Despite geopolitical uncertainties—over the fate of Europe, conflict in the Middle East and the showdown between America and China—markets have refused to melt down. Calm markets and high share prices make perfect sense in a world which remains roughly as peaceful and as globalised as investors have come to expect. In different circumstances, however, a dramatic revaluation of the price of everything from homes to shares to commodities could be in order. South Sea Company investors reckoned a New World was bound to be a wildly profitable one. In 2020, as in 1720, they may discover that this is not always the case.

This article appeared in the Finance section of the print edition under the headline “South Sea stories”