Central Park, Wall Street and Bubbles — Wall Street Entertainers

Central Park is the venue for the upcoming We Love NYC: The Homecoming Concert.

What better place could there be to celebrate life returning to (almost) normal in the Big Apple?

No matter what the season, Central Park is magical.

Summer brings apartment-bound families out to play. Kids love the outdoors. Kicking balls. Riding bikes. And chasing bubbles.

The Central Park entertainers know that if they capture the imaginations of children, they’ve also captured the wallets of the parents.

The kids watch as the bubbles are blown. Some burst before they’re formed. Others keep inflating and inflating. The children watch with a mixture of fascination and excitement.

Their laughter is infectious.

How big will this one be? They turn around to their parents with hands on mouths, their eyes dancing with the joy of witnessing something so magical. When the bubble is released, they run after it, willing it to float higher.


Source: Pinterest

Look at that face…innocent, happy, completely spellbound by the moment.

Seeing that look on the face of your child, no parent would ever say, ‘Don’t bother wasting your energy chasing the bubbles…they always burst.’

Instead, we let them enjoy the fantasy and the thrill of the challenge…chase the bubble and catch it and hold onto it.

When it comes to markets, that childlike innocence can and does carry through to our adult years.

Hop in a cab and travel around 8 miles (13km) south from Central Park, and you’ll arrive at another bubble blowing area of New York.

In this Downtown precinct, the ‘street’ entertainers also know that capturing imaginations is the surest way of capturing wallets.

The precinct?

Wall Street…the scene of the world’s biggest financial bubbles…1929, 2000, 2007 and (probably) 2021.

With each of these bubbles, there’s been a childlike belief in ‘this one being different’…this one will float higher and never burst.

Investors giggle with delight as the bubble keeps inflating.

The Wall Street entertainer knows he (or she) has a captive audience…gasping with amazement as the bubble exceeds the size of the previous one.

Perhaps, just perhaps, this one won’t have its Icarus moment.

The Central Park entertainers dip their bubble wands into a mixture of…detergent, baking powder, corn starch, glycerine and water. The thicker the mixture, the more durable the bubble.

Wall Street bubble blowers also have their formula…low rates, margin lending, recent outperformance data, made-up valuation metrics (that turn perennial loss-making entities into multibillion-dollar IPOs) and loads of positive spin.

The viscosity (sticky consistency) of this Wall Street mixture determines the size and duration of the bubble. That’s why some bubbles are bigger and last longer than others.

The latest bubble is the stickiest mix of all…record low rates, record level of margin lending, longest bull run, plenty of overhyped loss-making entities, and oodles of industry spin.

However, all the Wall Street bubbles have two (and possibly, three) common characteristics.

For insight into bubble formations, we refer to an article written by Rob Arnott (founder of Research Affiliates), Bradford Cornell, PhD, California Institute of Technology, and Shane Shepherd, PhD.

Most people would not be familiar with Rob Arnott…so here’s a little background on him and the firm he founded in 2002.

This is an extract from the company’s website…

Research Affiliates, LLC, is a global leader in smart beta and asset allocation. Dedicated to creating value for investors, we seek to have a profound impact on the global investment community through our insights and products.

As of June 30, 2021, [US]$171 billion in assets are managed worldwide using investment strategies developed by Research Affiliates.

A number of large global institutions contract Research Affiliates for asset allocation advice.

Having read a lot of Rob Arnott’s work over the years, I can confidently say he’s a seriously smart guy.

The title of the article he co-authored is ‘Yes. It’s a Bubble. So What?’.

The article outlined the author’s definition of bubble characteristics…

We define a bubble as a circumstance in which asset prices

  • offer little chance of any positive risk premium relative to bonds or cash, using any reasonable projection of expected cash flows, and
  • are sustained because investors believe they can sell the asset to someone else for a higher price tomorrow, with little regard for the underlying fundamentals.
  • Notably, there are markets in which few, if any, buyers care about discounted future cash flows to value the asset.

On the first characteristic, positive risk premium is industry-speak for ‘sustained upside’.

When it comes to valuations, there’s one golden rule…the higher the Price/Earnings (PE) ratio, the lower the future return will be…this is an established and irrefutable fact.

The higher the Cyclically-Adjusted PE, the lower the future returns.

As this chart shows, it is just so predictable:

Advisor Perspectives

Source: Advisor Perspectives

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High PE ratios invariably mean there’s little chance of any positive risk premium…in fact, the risk is all negative.

Here’s the latest CAPE reading for the US market. The second-highest reading in history…the Implied Future Return (over the next eight years), from this elevated level, is…MINUS 4.9% per annum.

Guru Focus

Source: Guru Focus

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The 1929 bubble delivered us The Great Depression.

The bursting of the 2000 dotcom bubble plunged the NASDAQ Index into a 78% loss.

The 2007 bubble led to the most severe economic contraction since The Great Depression.

Bubbles never end well.

Can the current bubble keep inflating and keep going higher without bursting?

If you believe that, I have a park in New York to sell you.

Everything we know about the history of financial markets — dating back to Tulip Mania — tells us this bubble is going to burst…big time.

We just don’t know when.

In the meantime, investors continue investing in the belief…they can sell the asset to someone else for a higher price tomorrow.

This is the ‘bigger fool theory’…people think they’ll be smart enough to get out before the brown stuff hits the fan. Selling to some fool who doesn’t know it’s going to bust.

Good luck with that strategy.

In my experience, people tend to want to hold out for just that little bit more…trying to extract every last cent out of their investment. Very few are content to ‘leave some on the table’ for the next person.

That requires perfect timing. Which we know has the same odds of happening as winning the Lotto.

It makes no sense unless, of course, you believe you’ll be able to sell for a higher price to someone else who isn’t as smart as you.

And, on the final characteristic…not caring about discounted future cash flows to value the asset.

Heck, who cares about cash flows — discounted or not — during a boom?

The insiders know the opportunity to capitalise on this market madness is not going to last forever.

As reported by Bloomberg on 27 June 2021 (emphasis added)…

If you think a rush by companies to sell their shares is a bad omen for the market, imagine a scenario where most of the sales come from firms that don’t make money.

It’s happening now. Since the end of March, almost 100 unprofitable U.S. companies, including GameStop Corp. and AMC Entertainment Holdings Inc., have raised money through secondary offerings, twice as many as coming from profitable firms, according to data compiled by Bloomberg.

A quick check of all three bubble indicators tells us we are most definitely in a bubble…a massive one.

The Research Affiliates report provides this sensible guidance on how much or how little an investor should invest in bubble conditions (emphasis is mine)…

Investors can actually provide their own most appropriate response to a bubble by answering a very simple question: “How much shortfall can I tolerate for two consecutive years without panicking?” Each investor has a unique threshold for “maverick risk,”.

Unless you’ve experienced a heartbreaking loss, you really don’t know at what level your panic threshold kicks in.

And, that threshold is different for everyone, depending upon…

Age. Capital invested. Investment outcome. Experience.

Here’s a ready reckoner on the impact a 65% loss on Wall Street would have on a portfolio…

Fat Tail Investment Research

If you need 90% or more of your current capital base to continue living at the level you’ve become accustomed to, then you should not have more than 10% of your portfolio exposed to markets.

For those who subscribe to the TINA line of thinking, the report offers this sage advice…

Investors can go their own way by not participating in the bubble.

When the current bubble bursts, people are going to have their hands to their mouths.

Aghast at what they are witnessing.

The only ones whose eyes will be dancing with joy are those who resisted having their imaginations and wallets captured by the Wall Street entertainers.


Vern Gowdie Signature

Vern Gowdie,
Editor, The Rum Rebellion

PS: The Rum Rebellion is a fantastic place to start your investment journey. We talk about the big trends driving the Australian Economy. Learn all about it here.

Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

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