In the world of seemingly ever increasing asset prices that is getting harder and harder to justify, it's easy to say that there is a bubble. A state in which the market is driven by speculation rather than fundamental performance should scare anyone who finds themselves exposed, but the reality is that this has gone on for at least a decade. When you look at cryptocurrency prices, stock prices, and real estate prices all over the world, the Covid pandemic looks like a speedbump that investors soon forgot about. People have been saying that this crazy run to higher highs will end soon for years, and their rationale was very logical, but humans have a tendency to act irrationally, and since the market is the total sum of human psychology, it behaves as the average human would.
Revisiting the pendulum
The acclaimed investor, Howard Marks aptly summed up public markets as a pendulum swinging between two polarities which can be summarised as being maximally pessimistic, and maximally optimistic.
I bring this up because it's easy for someone like me to say that we are in a huge speculative bubble, but that doesn't really help you. Its easy to say that markets are on the optimistic side of the pendulum swing, but you really shouldn't care about this statement, because that is 50% of the possible places for market sentiment to be.
It's almost impossible to see how far from the centre of the swing we are, but what is possible is to see how far from the extremity we are. We have to look for pessimism, fear and logic. When we can no longer find it, that is precisely the moment to get out.
Blessing in disguise
For those of you attuned to economic news, you will note that the big story of the week is the possible default on debt by China's second largest property development company Evergrande. It looks as though the Chinese government will let the property giants fall, which will cause major shocks to the Chinese economy.
While major, it seems as though this will not be a contagion event - it will not shock the global economic system, but it may present a drag on it.
So why is it a blessing? It gave us a barometer of market sentiment. On Monday (20/9/2021 for future readers), stock prices of property developers in China plummeted, and there was a major sell-off in all of the major international stock markets, which is great news. The markets aptly priced in the risk immediately.
Why is this good?
During the internet bubble the NASDAQ (The tech stock index) rose by over 80% in the six months before the crash. The stock market continued to rise despite the collapse of the housing market in 2007 and 2008. We also saw euphoric prices for two-three months during the initial outbreak of COVID-19. The last three major stock market crashes saw a complete abandonment of reason and risk assessment before the inevitable took place.
Contrast that to the events of this week, and we can see that common sense is still being used, meaning there is further room for the pendulum to swing, and market prices to soar. Which means more opportunities for us.
What next?
This is by no means an advertisement for you to put everything in investments like stocks, crypto and real estate. I want to make that clear. I personally find it hard to come to terms with most of the movements we see in the markets which can only be described as extremely close to maximal optimism.
"Be fearful when others are greedy and be greedy when others are fearful."
- Warren Buffett
The above quote is perhaps the best advice that can be given. In a state of being fearful, it is best to be sceptical of every opportunity, and not cynical, which is where many of the doomsday voices have it wrong, and as a result, have missed out on one of the all-time great opportunities to invest.
Previous Articles on this Topic
Takeaways
To find how far we are from maximum optimism, need to find evidence of the contrary
The Evergrande events were a clear barometer that there is still fear of risk in markets
In a period of a bubble, the sceptic is rewarded more than the cynic and the blind optimist
Coming Soon...
The Centralisation Backlash
Proof in Crypto
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