We’re only just starting to recover from the effects of a pandemic that closed much of the global economy. Huge job loses are predicted all around the world. And yet, global equity markets have climbed more than 80% since the crash of March 2020, adding $50 trillion in value. Perhaps not surprisingly, an increasing number of market experts are pointing to signs of investor euphoria and warning that we may be in a bubble that’s about to burst.
Writing in the FT last week, one respected commentator warned: “The last time we saw such an upbeat zeitgeist that did not coincide with an immediate equity market correction was in 1999 when the dotcom bubble was in full bloom.”
So, are we in a bubble? Indeed, are bubbles inevitable? And if so, what are the signs to look out for?
ROBIN POWELL has been interviewing bubble expert JOHN TURNER, Professor of Finance and Financial History at Queen’s University Belfast. Professor Turner is the co-author, with William Quinn, of a new book, Boom and Bust: A Global History of Financial Bubbles. The interview is in two parts. Here’s Part 1.
Is the boom-and-bust cycle just a fact of life for investors? In other words, are bubbles inevitable?
I always take a very long-run perspective on these types of questions. By a long-run perspective — I mean hundreds of years — the lesson of history is that economies do go through booms and busts. So bubbles are inevitable, and I suppose the interesting question is: why do these happen? So historically it might have been the weather and crop failure that were driving booms and busts. But when you come into the industrial era, it becomes more complicated to understand. Human psychology, of course, is playing a role; central banks and money play a role. But bubbles do seem to be inevitable, despite what Gordon Brown once famously said when he was Chancellor of the Exchequer: “No more boom and bust.”
What, in your view, are the likeliest causes of market crashes in modern times?
In the modern era, one of the main drivers of booms and busts is the role of monetary policy and of credit policy. So, within modern economies, we’ve reduced lending standards, we’ve liberalised banking systems, and that really seems to be behind a lot of the major booms and busts. Indeed, a lot of the market crashes that have had serious consequences for economies have been underpinned by this easy lending, by banks, and this flooding of credit onto the market. That seems to me, in the modern era, to be the main driver.
What about the current situation? Is there a danger that the availability of “free money” today might stoke a bubble?
There are two things going on here. When interest rates are so low, it can stimulate borrowing; and people borrow to buy “bubble assets”. So that bubble asset could be a house, it could be land, it could be bitcoin, it could be stocks and shares. That’s one thing. The second thing that low interest rates do — and we see this in historical bubbles — is that it causes investors to reach for yield. Walter Bagehot, the former editor of The Economist and literary critic, had a saying that “John Bull can stand many things, but he can’t withstand two per cent.” In other words, investors don’t like low interest rates! When low interest rates are prevailing in the economy, they tend to reach for riskier assets and start investing in riskier assets. That’s also something that we see happening in historical bubbles.
So how much of a threat is this reaching for extra yield to investors today?
I do think, when you look at bitcoin and you see people piling into it, and then going into technology companies in the United States, that investors are reaching for yield today. That reaching for yield could be driving some of the boom that we’re seeing in tech stocks, some of the boom that we’re seeing in the likes of bitcoin. I suppose one of the dangers too is that people go into riskier assets, but they also go into less liquid assets. During the boom times, that’s not a problem; but when the crash hits, as we saw with Neil Woodford, there’s a scramble for liquidity, and that can really leave investors high and dry. I’m concerned that there is reaching for yield today.
There’s a tendency for people to confuse the stock market and the economy and to misunderstand the extent to which the two are connected. How closely do booms and busts in the economy actually correlate with bull and bear markets?
This is a really interesting question, and it’s something I’ve looked at for the UK market over the past couple of hundred years. How closely connected is what’s happening in the real economy to what’s happening in the stock market? In a piece of work that I’ve done with a couple of co-authors, what I’m finding is that the stock market is two months ahead of the real economy. So the stock market is forward-looking, it’s looking into the future, and what it expects profits of companies to be in the future. It seems to be a good predictor. However, there is a question today regarding the stock market as to whether it’s a sideshow, to some extent, that it’s not really reflecting the overall economy any more. So you look at the US stock market at the minute and, going through a pandemic, you wouldn’t expect the stock market to be doing particularly well. But it has been. And that’s because of a small number of stocks: Tesla and the so-called “FAANG” stocks have been driving the returns on the US stock market. And then there’s the question of how representative those FAANG stocks are of the overall economy.
The economy has clearly had a humongous shock, and it’s hard to imagine that, two months from now, things will be as good as current prices suggest they will, isn’t it?
Yes, that’s particularly the case for the market in the US. I think it’s also the case for many other markets. I’m not so sure about the UK market. It’s done OK during the pandemic but, relative to what’s been going on in other economies, it hasn’t performed that well. That’s possibly because the UK market has been dragged back by large oil producers and companies that haven’t necessarily been performing that well during the pandemic. In the US, it’s the tech firms that have actually had a “good pandemic”, in terms of an increase in demand for their services.
You look at a number of historical crashes in your book. I know it’s a big question but, broadly speaking, what lessons can investors learn from these crashes?
There’s a metaphor that we use throughout the book, and the metaphor comes from the “fire triangle” in chemistry. So, for a fire to happen, you need heat, oxygen, and fuel. Then the spark happens, and the fire kicks off.
We see a “bubble triangle” in all of these historical episodes. So there are three things that you need for a bubble. First of all, as we’ve already talked about, you need low interest rates and easy borrowing conditions. That’s the fuel for the bubble. Then there’s the oxygen for the bubble, which is marketability. What we observe in each of these historical bubbles is that, thanks to technology or regulation, things become a lot more marketable. It’s a lot easier to buy or sell marketable assets. Then the third thing that we observe in all these bubbles is the heat, which we call the speculation. In all of these bubbles, we see novice investors, amateur investors, people entering the stock market for the very first time. These three things are very common in all of these bubbles — speculation, marketability and easy money in credit.
All of the bubbles then require a spark, and this is where there’s no common theme across these bubbles. A radical new technology could be the thing that sparks speculation, a political action or decision can spark the speculation, and those two things are really hard to identify and they’re different in every bubble. But the three common elements are the same.
You can definitely see plenty of people on the internet today who are talking about stocks as if they’re experts when they clearly lack investing or trading experience. They’re the modern equivalent of the shoeshine boy that Joe Kennedy famously referred to.
Again, in all of these historical bubbles, that’s what you see — novices rushing into the market, shoeshine boys, as you say, or taxi drivers. As soon as they start talking about shares, that’s the time to be getting out. I was in Shenzhen in 2015 when the Chinese stock market was going through a huge bubble. I was meeting lots of people in the financial industry, but I was also meeting ordinary people and through translators talking to them. I was having taxi drivers talk to me about the latest tech stocks being launched on the Shenzhen market. For me, as a historian, this was fascinating because I knew that we were in the middle of a bubble! And then today, with social media and all of these amateur millennial investors, there are warnings out there for us that something’s not right, when there are so many day traders, when it’s so easy through trading apps like Robinhood to buy and sell shares. I also think that if you’re seeing stuff for bitcoin pop up in your Twitter timeline, that’s almost the modern equivalent of the shoeshine boy.
Is there a danger, then, that all of these technologies — social media, trading apps and so on — could be fuelling a bubble?
Yes indeed. Going back to the bubble triangle, the marketability thing really has shot through the roof. It’s really easy to buy and sell. So many of these online stockbrokers are zero-commission — they allow you to buy fractional shares, particularly in the US where you’ve got some shares that are priced at thousands of dollars. So you can buy a fraction of a Tesla stock; you don’t even have to buy a whole Tesla stock. And then there’s the speculation, through Reddit, through these online discussion forums, through social media. Instead of the coffee house or the newspaper being the place that’s generating the excitement and bringing in amateur speculators, it’s social media. And social media moves so quickly compared to the traditional press, so you’re more likely to get herding effects, whereby more and more investors pile into particular stocks or assets like bitcoin. It really does fuel the rise in the asset price.
One of the concerns that I have about social media — and I think we’ve seen this recently — is manipulation. It is possible to manipulate people on social media. So you may have large, sophisticated investors either manipulating smaller investors or actually engaging in scanning social media and trying to ascertain, using artificial intelligence, what the mood and sentiment of investors is, and then they’re basing their trading strategies on that. In the book, we actually talk about social media in China. During the 2015 bubble, Chinese-controlled state press were going to do what the government wants and so they pumped the bubble, but they were also paying social media commentators to influence people. So people were being paid per social media comment to help pump up Chinese stocks.
The original interview with Professor Turner has been slightly edited for brevity and clarity.
In Part 2: If financial bubbles are inevitable, what, if anything, can investors do about them?
Boom and Bust: A Global History of Financial Bubbles by William Quinn and John D. Turner is published by Cambridge University Press. You can find more information on it here.
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Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.
