With the prices of some stocks, bonds and real estate listings reaching stratospheric levels, investors may fear that they’re facing an ever-expanding asset bubble.
And when it comes to bubbles, the concern is what will happen when they inevitably “pop,” causing demand to drop and assets to shed their value. For investors, that could mean holding an asset that is nearly worthless.
Have we entered bubble territory, or is this just a booming time for assets? Some experts argue that in today’s market, financial asset prices are high relative to historical levels.
Here’s what to know about whether stocks, real estate and bonds are in a bubble.
— Asset bubbles explained
— Are stocks in a bubble?
— Is real estate in a bubble?
— Are bonds in a bubble?
Asset Bubbles Explained
A bubble occurs when an asset’s price increases in a short period to unprecedented levels. This occurs when there is demand for a particular asset, resulting in a price surge that is often uncorrelated with the asset’s fundamentals.
Eventually, the bubble forms, reaches unsustainable levels and “pops.” When the bubble bursts, the asset’s price crashes, demand for the asset falls and other economic consequences follow.
To help explain what an asset bubble is, it’s illustrative to look back on the 17th century’s Dutch tulip mania, one of the most famous bubbles of all time.
In Holland during the 1600s, the tulip was among the most desired flowers. Initially, the high demand exceeded supply, which pushed prices to sky-high levels. As demand continued to blossom, farmers started growing more tulips. Eventually, tulip supply exceeded demand, and the tulip market reached its peak, with supply outstripping buyer needs.
Panic ensued, which caused the tulip bubble to burst, and tulip growers, investors and sellers lost fortunes overnight.
While today’s potential asset bubbles aren’t flower-powered, some of the same trends and investor fears apply.
Are Stocks in a Bubble?
The high prices some stocks have reached in 2021 may have investors craning their necks.
Big Tech stocks have helped push markets to all-time highs this year, with household names such as Google parent Alphabet Inc. ( GOOG, GOOGL) gaining about 90% year over year and Facebook Inc. ( FB) up about 40%.
Additionally, the S&P 500 is up about 32% in the last year and has gained approximately 100% since the pandemic-fueled crash of March 2020.
When these prices are totally divorced from stocks’ underlying fundamentals, a bubble may be looming on the horizon.
Here’s what’s happening: During the coronavirus pandemic, record amounts of stimulus fattened the U.S. economy, flowing into the markets and consumers’ pocketbooks. The Federal Reserve has been expanding its balance sheet, and that liquidity tends to get pumped into financial assets.
This has resulted in a rush of new brokerage account openings and a fresh wave of individual investors attracted to the stock market. These new investors tend to have a bullish sentiment toward stocks, leading them to purchase shares of big company names in droves. As a result, there’s a bidding up of stock prices.
Furthermore, given that interest rates are low, bonds are not yielding attractive returns. There’s a lot of liquidity in the market, and cash is not the best position since inflation is devaluing the dollar. In these conditions, investors see equities as a place to put some of their cash, which continues to push stocks higher.
Monetary and fiscal stimuli helped the economy recover from the pandemic, but much of that money found its way into stocks, says Steve Sosnick, chief strategist at Interactive Brokers.
Whether that love for stocks creates inflation is a matter of debate, Sosnick says. But he adds, “I think it’s clear that the first effect is creating asset price inflation. It takes more dollars to buy the same amount of shares in a given stock.”
One sector, in particular, that has driven up the value of the S&P 500 is the information technology sector. The Technology Select Sector SPDR ETF ( XLK) has a one -year return of roughly 38%. As stocks in the tech sector continue to rally, it’s worth asking whether these stocks are in the purview of bubble territory.
The Nasdaq large-cap tech companies such as Apple Inc. ( AAPL), Amazon.com Inc. ( AMZN), Microsoft Corp. ( MSFT) and Facebook are “very fully priced,” Sosnick says. But these stocks don’t necessarily constitute a bubble, he says.
“I don’t know that we can continue to see these kinds of levels of multiple expansion or even maintain these current multiples if the Fed is not as relentlessly accommodative as it has been,” Sosnick says.
Is Real Estate in a Bubble?
Real estate prices have soared throughout 2021. Many house hunters have experienced the bidding wars, rocketing prices and insane competition fetched by promising new properties. And this frenzy also applies to commercial real estate purchasing.
On the residential side, home prices have been increasing at a rapid pace and are very high compared to historical standards. Nationally, home prices increased 18% year over year in July 2021, with states such as Arizona, Idaho and Utah posting annual home price increases of more than 25%, according to CoreLogic.
The reason for this run-up in home prices is multifaceted. First, high demand is exceeding the low inventory of houses. This means there are fewer houses available for buyers looking for a home. As demand for homes increases, coupled with low supply, this puts pressure on home prices and inevitably leads to real estate asset prices increasing.
Second, the pandemic, which decimated the available workforce, delayed the building of new homes. Third, the cost of supplies needed to build homes has increased, which adds to the price of brand-new homes.
Low interest rates also make buying a home more attractive, with the cost to borrow money so low. Plus, as employees are working from home, they find they need more space. That makes moving out of the cities and into suburbs more attractive.
Most of the trends appearing today weren’t caused by the pandemic, but they were accelerated by it, says Doug Prickett, senior managing director of investments and analytics at Transwestern Investment Group, a real estate investment advisor based in Dallas.
“We’ve been undersupplied for some time, and that’s just exacerbated by the slowing supply for labor and materials to build homes,” he says.
So are these home price increases sustainable? Or are homebuyers locking themselves into a bubble?
“There is a point where pricing exceeds the ability to service the debt and the price, and we’re very close to that,” Prickett says. “It doesn’t mean it’s going to go backwards. It just means it’s going to slow down.”
Given that there is a shortage in the labor market, where there are more jobs than people to fill them, employers and businesses are paying more for workers’ wages.
“Inflation could help offset this increase in housing by giving us some inflation in wages, and that would allow us to service the debt we’ve taken on, thus not resulting in a bust,” Prickett says.
As for what comes next, “We’ve had a boom, I think we’re going to hit a plateau now, and we’re going to settle there for a while avoiding a bubble,” Prickett says.
Experts are generally divided on whether we’re in a boom or a bubble right now. But Prickett says, “Everything is expensive across all asset classes now.”
Along with single-family real estate, commercial real estate has also seen an increase in value. There are two primary segments that are receiving capital in the commercial real estate space: multifamily and industrial.
“Real estate is still providing yield,” Prickett says. “It’s also considered an inflation hedge, and instead of being evenly distributed across all sectors, it’s primarily going into industrial and multifamily commercial real estate sectors.”
Are Bonds in a Bubble?
As a result of the Fed buying hundreds of billions in bonds while keeping rates low, there has been an upward trend in bond price appreciation. As interest rates have been falling, bond prices have been increasing. In other words, when yields fall, that compels investors to buy up bonds, which boosts prices.
Retirees and near-retirees may eye this bubble potential with concern. Owning bonds is part of a traditional investment portfolio. Investors tend to hold bonds for their stable and consistent returns and income, but Treasury yields are low compared with historical standards.
Another area of concern is the corporate bond market, which consists of more than $10 trillion of debt, according to the Securities Industry and Financial Markets Association. Given the low-interest-rate environment, companies are taking on cheap and sometimes highly leveraged debt.
When companies carry high debt levels, this can cause bonds to have to change their credit rating. If corporate bonds are downgraded, it could be a catalyst for a sell-off among these assets.
When the Fed announced that it would buy corporate bonds in March 2020, companies were able to raise more debt and increase their leverage. This provided a safety net for these noninvestment grade bonds, increasing investors’ confidence in these risky assets, says Majeed Simaan, assistant professor of finance and financial engineering at the School of Business at Stevens Institute of Technology.
Simaan references the increase in SPDR Bloomberg Barclays High Yield Bond ETF ( JNK) following the Fed’s announcement.
“When the Fed announced its unprecedented policy of purchasing corporate bonds on March 23, 2020, the ETF” jumped 32%, Simaan says. Despite the turmoil 2020 brought, the ETF finished out 2020 with a 5% gain.
Overall, Simaan says, it’s difficult to say whether there is a debt bubble.
With accommodative financial policy, Simaan says, firms that had weak balance sheets survived. “However, at some point the music will stop — the result of which could lead to complicated firm restructuring, given the debt that has already been accumulated prior to the pandemic,” he says.
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Are Stocks, Real Estate and Bonds in Asset Bubbles? originally appeared on usnews.com