Published in Newsweek Japan February 1st 2021
The Covid crisis drags on, spreading gloom and despair everywhere, yet stock markets are on fire. Since markets bottomed out in March 2020, the Nikkei 225 and America’s S&P Index have both risen by over 70%, while the tech-stuffed NASDAQ Index has doubled.
Covid has been very good news for the stock prices of “stay at home” beneficiaries, from Zoom to Nintendo, but there is more to it than strong earnings. The familiar dynamics of a bubble have become impossible to ignore.
In his classic study of bubbles, “Extraordinary Popular Delusions and the Madness of Crowds”, Charles Mackay, writing in 1841, explained how men “go mad in herds, while they only recover their senses slowly and one by one.” One hundred and forty years later, comedian Beat Takeshi quipped that “it’s not scary to cross on a red light if everyone does it together.”
That was at the start of the decade marked by Japan’s stupendous asset bubble. At its zenith, the Tokyo stock market had a greater value than all other stock markets in the world put together, and the grounds of the Imperial Palace were theoretically worth more than the total land mass of the state of California. The subsequent collapse did immense damage, as shown by the surge in bankruptcies and suicides over the next decade.
All this seems crazy in retrospect, but at the time sky-high asset prices and heavy borrowing and heavy spending were regarded as perfectly natural. Human beings are social animals programmed to copy our fellows. This is how we learn to walk and talk. It is also how intellectual fads and financial manias spread like epidemics.
Bubbles are intrinsic to human nature, but they are also quite rare. They need a particular set of circumstances to grow from small-scale speculation into an epoch-defining phenomenon. The first and most and most important requirement is excess liquidity, lots of it over an extended period of time. That usually requires some sort of crisis which central banks are determined to overcome with super-loose monetary policy.
In the case of the Japanese bubble of the 1980s, the threat was the extraordinary rise in the yen engineered by the G7. If left untreated, the three year surge from 260 to 120 versus the dollar might well have plunged Japan into severe recession. Of course, hindsight now tells us that the reckoning was not avoided, but merely delayed a few years and made immeasurably worse.
A lesser bubble, the dotcom mania at the turn of the century, was fuelled by central banks in fear of the “millennium bug,” a software glitch which, according to some IT gurus, would somehow wreak worldwide devastation.
Now we have another kind of threat – the coronavirus crisis. The response of governments across the developed world has been to unleash a torrent of liquidity that dwarfs all previous emergency measures. Growth in the money supply is at a thirty year high in Japan, and in America at a level well above the highest levels of the inflationary 1970s.
Opening the monetary spigots is a necessary condition for a first-class bubble, but not a sufficient one. You need something else, a future dreamscape that is both beguiling and uncertain enough to be hard to value through conventional methods. In other words, new frontiers of some sort.
The unknown territory that dazzled eighteenth century Britain was geographical, the mineral-rich areas of South America that would be exploited, supposedly, by the South Sea Company. In 1980s Japan, there were many new ideas and technologies to excite investors, but probably the most influential was that particularly dangerous form of innovation, a new method of valuing stocks. Instead of measuring the worth of a stock by the earnings and dividends a company generated, people used the “Q ratio” instead. That took into account all the land and stocks it held on its balance and valued them at bubble valuations. The more the bubble inflated, the better those balance sheets looked.
Today, we think we are wiser, but the thrill of new horizons can still overcome our judgement and cause us to succumb to “FOMO” (Fear of Missing Out). In his book, Charles Mackay lists dozens of dodgy ventures that were floated during the era of the South Sea Bubble, including “a company for carrying on an undertaking of great advantage, but nobody to know what it is.” After collecting the funds from subscribers, the promoter fled to France and was never heard of again.
Ridiculous as that sounds, it is not a million miles away from the many SPACs (Special Purpose Acquisition Vehicles) that have been launched on the US markets in recent months. Investors happily subscribe 80% of the capital to these “blank cheque shell companies” without knowing what it will be used for.
Mackay also describes the tulip bubble, a speculative frenzy that gripped Holland in 1680. Apparently, a drunken sailor mistook a particularly valuable bulb for an onion and ate it. An absurd story, but hardly different from recent news items about cryptocurrency speculators who have lost their passwords and cannot access their vast paper profits. Bitcoins have no intrinsic worth, so any price is possible. Not for nothing have they been dubbed “digital tulips.” Though you can’t even eat them.
The dotcom bubble of 1999-2000 was driven by the exciting prospect of a new technological frontier, cyberspace. The rapid diffusion of the internet turned out to be as transformational as the visionaries claimed, but that did not justify the astronomical valuations that investors were paying for many of the flimsy and profitless stocks that had come to the market. As is often the case with bubbles, what started out as a good idea was taken much too far.
The internet giant of the era was AOL (American Online), soon to be left high and dry when dial-up connections gave way to broadband. It disappeared off the radar screen in 2009. During the dotcom frenzy, neither Google nor Netflix had gone public, Facebook had not been founded and Apple had yet to release the I-pod. The only one of today’s FAANGs that was hot was Amazon.com and even that stock lingered unloved for almost ten years after the crash. Likewise, Japan’s Softbank is only now matching the giddy heights it attained in February 2000.
In other words, bubbles are complicated and confusing. Even when you are right about the idea, you can be wrong about the particular stock. Even when you are right about the stock, you can be wrong about the most important thing of all – the price you pay.
Today’s Covid bubble has many similarities with the dotcom bubble of twenty years ago. The new frontier is again technological – 5G, green energy, electric vehicles, “sharing” companies like Air B’n B and “stay at home” winners. It is not a whole economy phenomenon, as was the case with the Japanese bubble of the 1980s, but a limited, though powerful mania. That is why many markets in the world, Japan’s included, are not excessively expensive on conventional valuations. Lots of stocks remain earthbound, while the chosen few have ascended to the heavens.
As is ever the case in such circumstances, investors extrapolate current trends into the long-term and refuse to acknowledge the many alternate futures branching ahead of us wherever we look. The Covid crisis is finite. At some point, people will return to restaurants and eat out less. Many will return to cinemas, as we see from the record-breaking box-office success of Japan’s “Demon Slayer” and China’s “The Eight Hundred.”
Already, several of the American internet giants are confronting the threat of regulation. Meanwhile, green energy should come under greater scrutiny as unexpected externalities and supply problems loom larger. Even more fateful would be another technological breakthrough that, like the advent of broadband, overturns prevailing assumptions about winners and losers.
It doesn’t take much to go wrong when stocks are priced for perfection, but that is no reason to give up on investment entirely. There are plenty of solid companies with reasonable stock prices in Japan and elsewhere. Hard though it is to ignore the hype, the best approach is to remember that you are buying “a share”, in other words a portion, of the company. Would you like to own the entire company at that price, bearing in mind its earning power and probable growth? If the answer is “no”, you’d better not invest.
All bubbles end by bursting, and this will be no exception. When and how will it happen? Bad news won’t matter; investors will assume, probably correctly, that another flood of government support will arrive. What the holders of expensive stocks should fear is good news; specifically, an economic recovery strong enough to push up interest rates. Regardless of what governments and central bankers say now, that is when they will withdraw emergency measures. At that point, you must be sure that your investments are solid and sensibly priced.
Legendary investor Sir John Templeton once declared that “bull markets are born in pessimism, grow amongst scepticism, mature amongst optimism and disappear amongst euphoria.” I wonder what he would think of bipolar markets that are ecstatic about high-priced glamour stocks and depressively downbeat about the rest.