Spencer Nurse Managing Director - Investments Oppenheimer & Co. Inc. 500 108th Ave. NE, Suite 2100 • Bellevue, WA 98004 425-709-0540 [email protected]

IS THE STOCK MARKET IN A BUBBLE?

I have received a few calls and questions lately if we are in a stock market bubble. There are several items to consider when there is a feverish feel to the markets, real estate, digital currencies, SPACs, or short squeezes created by social media posts. While most people are stuck at home, normal channels for energy, focus, and entertainment are shut down, the market has filled this need for some folks. Corners of the stock market certainly are frothy, inflated, and expensive, others are not. After over twenty five years in this profession, these are some of the indicators and strategies I have developed to monitor and manage for potential bubbles.

Mind the Valuation. Minding valuation and paying attention to what price is paid for a specific security matters. Extended valuations from historical means can persist for years. Eventually there is a price reversion to the mean or average. One of the most dangerous catch phrases I hear is “it’s different this time.” Although valuations are at the upper end, in a zero to negative GDP growth environment this puts a premium on investments, companies’ stocks that are providing good growth in revenues and earnings. As a result, valuations expand and are more expensive than historical averages. This by itself does not necessarily indicate a broad based stock market bubble.

You Can’t Fight the Fed. Many talking heads claim we are in a bubble as markets trade above normal historical valuations. What they fail to consider is that the stock market does not operate in a vacuum. Interest rates play a large role in alternatives to investing in stocks. With the Federal Reserve providing large amounts of liquidity to markets and pegging interest rates near zero, there are not a lot of good alternatives for yield other than stocks. Investors can earn a dividend of 2% to 3% while they hold a stock, with potential appreciation as well. Dividends pay much more than the 10 year Treasury bond with a current interest of 1.62%. If the 10 year Treasury bond rate moves up to 2% - 2.50% this may well provide what is needed for markets to pause or correct. The steepening of the yield curve is a positive sign for the economy as this is a sign for a rebound in the economy. There is an old adage on Wall Street, “You can’t fight the Fed.” The Federal Reserve has made it clear it will continue to provide large amounts of liquidity for the foreseeable future to aid an economic recovery, full employment, and price stability (inflation). The Fed would much rather overshoot with higher inflation than run the risk of deflation or stagflation.

Remain Diversified. Remaining diversified is important to protecting a portfolio from corrections. Lately, money has been shifting out of growth stocks (i.e. tech) to value stocks (i.e. banks, small companies). Value stocks don’t grow earnings as fast, are in mature industries, and usually pay a dividend. Having a barbell approach investing in both value and growth, helps protect against any one sector, segment correcting and adversely impacting a portfolio. Value segments of the stock market are trading below historical averages on valuation and have recently appreciated more than technology stocks.

Emergency Cash. To weather the ups and downs of the stock market I suggest investors have emergency cash to that can carry them through three to twelve months. The most detrimental to the longevity of investors’ money is having to sell after the market has fallen. If you have enough reserves, or non-stock investments to carry you through a downturn, this can help dramatically. This emergency cash helps investors mentally to be able weather the stock market volatility and have better appreciation over a longer period of time.

Investor Sentiment. Typically, when investors feel the most giddy, positive, the markets can be extended and due for a correction or pause. The best returns for investors have been made when investing during an environment that looks the bleakest after the market has fallen. In late April, early May due to COVID and the stock market falling, negative (bearish) investor sentiment was at 53% as investors were negative about future prospects. Today, negative investor sentiment is at 25%. This is known as a contrarian indicator, sometimes signaling the opposite of what the measure actually says about current emotions. This behavioral finance measure is not foolproof but can help add clarity toward caution in deploying new capital or being a bit more defensive at times.

Not Timing the Market. This is the costliest mistake for investors and the most common. While it can make sense to be a bit cautious at times, trim (sell) some holdings, being all in or all out of the market can be detrimental to long term success. As humans, survival is paramount, and money is key to this survival. However, the best time to invest is when it is the most difficult and scary emotionally.

There are corners of the markets that are attracting fast speculative money with little to no regard for valuation, proof of concept, or future earnings. Other areas of the markets remain below historical valuation levels and still represent good opportunities long term. When taking into account low interest rates, growth can carry a premium above historical measures. Stay diversified, have a flexible plan, maintain emergency cash, avoid speculative corners of markets and be prepared for markets to correct from time to time.