Are we in a stock market bubble?
I am not sure about you, but I get too many investing tips from friends lately. Friends that haven’t cared much about investing before. Some ask for my opinion. Others insist I buy hot stocks like Chinese EV manufacturers.
There’s also a big boom in trading apps like Revolut, Robinhood and FreeTrade.
Now there’s nothing wrong with that. I’m all up for discussing investing all day long. But I feel it’s too easy to make money these days. That’s the reason most people are now interested in joining the party. It shouldn’t be that easy.
The stock market should be like climbing a “wall of worry” not a steady rise upwards. Sure we had the -30% drop in march but we also had the quickest recovery in history! Of course, we’d prefer if risky assets like property and stocks offered 7% per year, steady. But -10% one year and +20% the next one is what we’re getting instead.
If risky assets only went up, then there wouldn’t be any risk for buying them.
The theory of investing is simple. If you want safety with bonds, you’ll get a low return. If you want high expected returns with stocks, you’re going to have to take the risk that sometimes you’ll get a lot less than you expected.
It is hard to wrap our heads around that statement but the risk of not getting great returns is what makes risky assets offer them.
Our money has historically doubled every 7-10 years when investing in property, stocks etc.
To get those rewards we have to accept the short term pain. 10% drop every couple of years, 20% every 7 years and a 50% drop every 30 years. So at least once in our lifetime.
Think about the investor who put money in 2000 and didn’t break even until 2012. That’s 12 years later! Today we invest £1000 and expect it to be £1200 end of the year. At least that’s the general feeling I get from reading online, talking to people and gauging interest & expectations.
The thing is, I don’t see any pain right now in investing.
It’s just too easy to make money. Most assets in 2020 are higher than their pre-covid levels. If you bought post-covid then you’re probably better off by a big margin. Unless you only invested in the UK where FTSE 100 still trades at -15% pre-covid levels. Or invested in lousy oil futures as I did.
See how different asset classes performed in 2020.
I don’t see bitcoin in there, probably because it’ll skew the graph! People are making some good profits right now, and I’m happy to be on that train. I just know that it shouldn’t be that easy.
UK property defeats gravity once again
UK property, on aggregate, has exceeded expectations (at least mine!). I wouldn’t have thought that a pandemic would actually cause house prices to increase.
I mean, sure, you spend more time in your own home than at office/cafes/restaurants. So there must be a higher demand for space. It’s also one of the reasons central flats like mine and places without outside space are out of fashion. Bigger places often at a distance from the city centre are now in high demand.
Hometrack reports a +4.3% UK growth in house prices between Jan 2020-21. And here’s a picture from the Rightmove asking prices.
But still, there’s high unemployment, people being sick, everyone tries to keep some cash on the side just in case, right?. How could UK property outperform?
Higher demand for housing is only part of the reason. I guess the property tax cuts played their role too. They favour buying now rather than later to save on stamp duty. It won’t last long. Those furlough payments put the government in more debt and it’s going to come from taxpayers eventually (who’s looking forward to March Budget?).
My proxy to property, Property partner, however, is another story. Properties trade at big 20% discount to their “net asset value” as measured by an independent surveyor. Investors think not. They are not willing to pay the price for UK properties despite what the market says. Of course, there are fees, loss of trust in property partner etc which should not be underestimated.
I think part of the problem is that they’ve paused paying out the rent in most properties. People (including myself) don’t like that. They’ve recently started adding properties back to paying mode now. Next statement will be 31st of March 2021 where they’ll announce the next batch of properties that’ll start paying dividends again.
In case you want to speculate, here’s an interesting stat: For 15 properties announced on 18 December 2020, their share prices increased by an average of 8.5%. But the overall picture is not looking good.
Should I wait for the stock market to crash?
So if making money is too easy and assuming we’re in a bubble, then we’re due for a correction… right?
Yes! But nobody knows if when this correction will come. Should I wait before I invest my cash?
Here’s the thing.
Overall, the stock markets, property and risky assets are driven by fundamentals – productivity, population growth and innovation. I don’t want to sound like a pessimist but just because risky assets are higher it doesn’t mean that the fundamentals have improved by much. We just pay a higher price for it.
I quite liked this analogy from Roche, one of my favourite authors:
Stocks just reflect the underlying business to some degree and the firms mostly don’t care who owns their shares and the markets don’t impact the actual companies all that much. That is, a secondary market is a lot like a horse track with betting. The horses run the actual race and the bettors do stuff that reflects the value of those horses. But the bets don’t actually make the horses run faster or slower.
Cullen Roche
Therefore if we’re now paying a higher price for the same “horse” compared to last year – all things being equal – we should expect a lower return.
Now that’s far from saying we should not invest. We should ALWAYS invest 🙂 Just come with lower expectations.
And we should not wait for the stock market to crash before we invest. If something, we should make our portfolio more defensive by adding more high-quality bonds and diversify in other asset classes and across geographies.
For starters, waiting for a market correction is so mentally exhausting.
Then by the time it crashes, we might make such a high return and never meet the previous low level. Anyone waiting for a stock market crash in 2016 when the market was also overvalued is now still waiting. But now the market has to crash by more than 50% to meet the January 2016 level!! Which of course may never happen.
As if that’s not enough, young investors should actually pray for market fall. They buy the same stocks at a much lower level.
Overall, waiting for a crash is not a great strategy for the simple mathematical reason, that the market is mostly moving upwards. Instead, having a predefined asset allocation can work wonders if you rebalance. That’s because you sell high and buy low. Automatically.
The next time I’ll write about the secret power of diversification. Everyone knows that putting your eggs in many baskets is a safety-first strategy. It’s intuitive (and boring to be honest).
But I’ll explain how our total return is higher than the sum of its parts. Mindblowing, at least to me!
How has your portfolio performed in 2020? I think a key theme in 2021 is fear of missing out (FOMO). When you see so many people around you make a quick buck (hi Tesla, BTC, GameStop) and you’re sitting on boring index funds and bonds. I certainly suffer from it and try my best not to succumb! But this was the strategy that brought me a step closer to financial independence. Why waste it now?