Most people remember the Great Recession of 2008/9 as a real estate bubble that burst. That’s not wrong, but it doesn’t tell enough of the story. The bubble that burst was the mortgage market, not real estate, and it nearly took down the world’s greatest financial system.
Today, there is understandable concern that we are experiencing yet another bubble. A tsunami of liquidity must produce a bubble somewhere! It is hard to argue that real estate is not in a bubble again. It is hard to argue that bitcoin is not in a bubble, as well as other asset classes, like art & collectibles. But, there is a huge difference . . . our financial system is not in a bubble. One reason is because mortgages are much better underwritten today. Plus, banks are better capitalized and restricted from more speculative activities.
In 2008/9, there was one huge bubble . . . in mortgage lending. Today, it is more like “whack-a-mole” with smaller bubbles popping up. How can we not have bubbles, when the Fed is supporting the economy so strongly? Real estate prices are, yes, in a bubble but mortgages are not. That bubble will fix itself, when interest rates rise, causing demand for real estate to fall, driving down the cost of real estate. The bubble around bitcoin and other crypto-currencies will subside when investors understand that crypto-currencies are nothing more than a one-dimensional alternative to multi-dimensional gold, a sort of digital collectible. We have more asset bubbles today than we did in 2008/9, but they are relatively small bubbles.
Of course, the question is whether the stock market is in a bubble. By some measures, it is in a bubble, because price-earning ratios are uncomfortably high, about 23-25X. But, higher PE ratios are appropriate when earnings are growing rapidly, which is the case today. In addition, higher PE ratios are appropriate when the Fed is so very accommodative. If the stock market is in a bubble, it is not a dangerous bubble. When earnings stall, when the Fed starts raising interest rates, when alternative opportunities are available . . . the stock market will deflate somewhat, and that’s a good thing.
There are so many things to lose sleep over . . . this is not one of them!