A Bursting Bubble’s Effect on the 401k

It would appear that nothing can pop the current stock market bubble, but there is one pretty straightforward “pin” that will probably do the job, namely rising interest rates.

Central banks around the world have embraced zero interest rate policy (ZIRP), but they can’t control long rates and that reality has begun to take place as I write this article.

I argue that (1) bubbles currently exist even though we are being gaslit into denying their existence, (2) there are understandable reasons bubbles continue to inflate despite economic woes, and (3) several pins can pop these bubbles and one is my odds-on favorite.

9 ‘Expensiveness’ Measures

It’s official. The rebound from the March 2020 crash is a V-shaped recovery and it only took 4 months, which is much quicker than the typical recovery that takes 4 years. And it gets even better. The return on the S&P 500 over the 12 months following the crash is an astonishing 76%! This is a 3.6 sigma event, very highly significant relative to the 10% average annual return on the S&P500. For perspective, the Great Depression lasted a decade and had 10 “W” type recovery/loss cycles.

This recent run-up brings the Buffett Bubble Barometer to its highest level ever at 220%, well above its 80% average. The value of the stock market is now 220% of GDP (gross domestic product).

And there are eight more expensiveness measures all indicating a stock market bubble. Wall Street is gaslighting us into believing that there is no bubble because they want investors to stay in the market. It’s true that most bubbles are confirmed after they pop, but this current bubble is a whopper that baffles most with its tenacity. A bubble exists when prices are far higher than fair value.

Price/earnings ratio (P/E) is among the most popular bubble metrics, with a “fair” historical value of 15. It is currently above 30, and in the territory that has preceded previous bubble bursts.  And there are other such ratios that are also in bubble territory like those shown by Lance Roberts in the following where red indicates the economic sectors that are overpriced.

Similarly, the following picture is an example that uses a family of four expensiveness measures, from Jill Mislinski.

There is also a bubble in the bond market. Our government, as well as other governments, are implementing a “Zero Interests Rate Policy” (ZIRP), manipulating interest rates to artificially low levels in order to keep borrowing costs under control on our mounting debt.

We have a debt crisis. As discussed below, this crisis is one of the pins that could burst the stock market bubble. The bond market bubble exists because our government wants it to exist. The reasons for the stock market bubble are more complex and varied.

15 explanations for the stock market bubble

I can think of 15 reasons for the current stock market bubble, most of which are wishful thinking.

1. Investors believe that vaccines will cure the pandemic quickly, and
2. Earnings will soar in an economic recovery like no other
3. The Federal Reserve will support stock and bond markets, dumping $trillions
4. Low interest rates cause high stock prices. This is the reason that most investment firms use. They must live with the counterpoint that increases in interest rates will reduce stock prices.
5. Investor greed: FOMO is fear of missing out
6. Investor euphoria: Hopium is the drug that gives hope for a bright future
7. Huge foreign demand for US securities. Foreigners fear the devaluation of their currencies and view the US as “the cleanest dirty shirt in the laundry basket.”
8. 92 million Millennials believe markets only go up and are actively trading on Robin Hood, Robos, and the like
9. The FAANG Stock phenomenon where investors believe mega-companies will perform well regardless of the economy.
10. Apple is worth a $trillion and Tesla is worth more than their competitors combined
11. The election. The stock market is up so far since Joe Biden took office
12. A belief that amateurs can beat Wall Street with short squeezes on the likes of GameStop and silver.
13. Stock buybacks capitalize on low borrowing costs.
14. SPACs: Special Purpose Acquisition Companies
15. IPOs: Initial Public Offerings

10 pins capable of bursting bubbles

The laws of physics limit the size of bubbles – they all burst when overinflated. They can burst on their own, but most of the time some event triggers a burst, after which everyone agrees that there was a bubble. Two of our most-watched videos are Ten Threats Facing Investors and The Stock Market Will Reconnect With the Economy where we discuss the following threats to the economy and stock market.

      10 Threats

1. COVID monetary cost
2. Inflation
3. COVID human loss
4. Global debt crisis
5. Trade wars
6. Nuclear threats
7. Social Security bankrupt
8. Medicare bankrupt
9. Real estate bubble
10. Social unrest caused by wealth divide

My pick is a combination of the top two – the costs of COVID relief combine with other money printing to create serious inflation, maybe even hyperinflation, that in turn forces interest rates to increase.

Rising Interest Rates

Any one of these threats could burst the bubbles, but I think the following scenario is likely:

• Interest rates will rise and creditworthy foreign governments like China are paying higher interest. 10-year Chinese government bonds currently yield more than 3%, more than twice US Treasuries. And some countries, like Brazil, are paying more than 9% on their 10-year governments.
• Money printing continues to run amuck and will cause rampant inflation, maybe even hyperinflation. See my upcoming article on the impact of $13 trillion in new money.
• Stock prices will fall because forecasted earnings will be discounted at a higher rate and higher bond yields will entice investors back to bonds.
• The government will be forced to monetize the debt in order to pay interest, creating a debt spiral.

Others agree

Several respected investment authorities agree that bubbles will burst soon. Here are a few examples of recent videos:

• Jeremy Grantham: https://www.youtube.com/watch?v=RYfmRTyl56w&feature=youtu.be
• Harry Dent https://www.youtube.com/watch?v=lg51JrFpLzk makes the brave prediction that the stock market will crash in April 2021
• Ron Surz  https://youtu.be/n9QDdtD5wyc

We might be Cassandras, someone whose accurate prophecies are not believed. See https://en.wikipediasorg/wiki/Cassandra. Do you believe these prophecies?

Conclusion

401k investors should be moving to protect themselves, especially baby boomers. Most of our 78 million baby boomers will spend much of this decade in the Risk Zone spanning the 10 years before and after retirement. Losses in the Risk Zone can make remaining lifetimes far less comfortable. The odds of avoiding a market crash in this decade are incredibly low.

I’ll be writing about the ways investors should protect themselves in the face of bursting bubbles, especially 401k investors.

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Ronald J. Surz is co-host of the Baby Boomer Investing Show and president of Target Date Solutions and Age Sage, and CEO of GlidePath Wealth Management. Target Date Solutions serves institutional investors, namely 401(k) plans. Age Sage serves do-it-yourself individual investors, and GlidePath serves individual investors who want an advisor.