Fisher Investments UK Reviews Equity Bubbles

Stock markets usually rise, and sometimes they go too far and become detached from reality – forming a bubble – but our research shows this is historically rare.[i] When Fisher Investments UK reviews equity bubbles, we find a few defining characteristics. Here we share why they occur, how to spot them and what you can do to navigate bubble chatter.

Fisher Investments UK’s reviews of market history show bubbles have two primary components: irrational demand and runaway equity supply. The former occurs when investor sentiment reaches euphoric heights. In this kind of environment, we have found the exuberance for owning equities can blind many investors to deteriorating fundamentals. As legendary investor Sir John Templeton described bull markets – sustained periods of generally rising equity prices: “Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria.”[ii]

But we don’t think insatiable demand alone means markets are in a bubble. Rather, Fisher Investments UK thinks a bubble also requires what Scottish journalist Charles Mackay described in 1841 as “the madness of crowds” – spurring companies to issue a glut of equities to feed irrational demand.[iii] In the modern era, we find this is when earnings expectations become so lofty reality can’t possibly match them. This usually involves people arguing traditional drivers and metrics don’t work anymore, that conventional ways of valuing companies are outmoded and the resulting paradigm shift will sweep away the old world. In the time before reality sets in – which may last for a while – market mania can spur explosive share issuance appealing to the masses wanting to buy into an apparent investment opportunity. When that proves illusory and firms can’t meet expectations, the bubble pops, and bear markets – fundamentally driven declines exceeding -20% – tend to follow, according to our research.

The 2000 dot-com bubble is a prime example of such supply overhangs, in Fisher Investments UK’s review. In the late-1990s, so-called new economy thinking led many to believe the Internet and digital commerce could suspend the business cycle, ushering in endless growth.[iv] Commentators we followed argued clicks – website traffic – mattered more than profits, and companies generating them could only go up. But our research showed companies without business models that drove adequate earnings growth weren’t viable. We observed many dot-coms burning through their cash whilst racking up steep losses. Though some dot-com firms were able to adopt sustainable business models and survive – with a handful eventually finding spectacular success – most didn’t.[v]

So, how can investors identify bubbles? One telltale sign in Fisher Investments UK’s reviews of the financial press is the widespread and overwhelming belief that equities move only higher, that they are a one-way road to riches without end. Based on our observations, major publications’ headlines splash these views on cover stories touting once-in-a-lifetime opportunities to the public. Not only does greed – or fear of missing out – appear to reign, but we have also found critics of the phenomenon roundly ignored, if not shouted down or ridiculed.

Our analysis of bubbles also shows margin debt – borrowing money from brokerages to buy equities – also tends to spike inordinately, which suggests some investors may be overlooking the risk of loss in pursuit of higher returns. We often see this occurring alongside initial public offering (IPO) frenzies, particularly from low-quality companies with suspect business models (having poor sales and earnings prospects). In our experience, investment bankers react to heightened demand for hot equities by pushing new firms to raise capital from the public. This surge in equities supply from low-quality IPO issuance amidst sky-high investor expectations can signal a bubble is forming.

Another potential bubble indicator: soaring valuations. Fisher Investments UK usually doesn’t find valuations (like price-to-earnings ratios) very helpful in determining equities’ direction because markets are forward looking and valuations use past prices, which aren’t predictive. In our view, these metrics typically reflect companies’ fundamental prospects already. However, big and sudden upward valuation moves may suggest euphoria is forming.

By knowing what to look for, we think investors can better navigate discussions of bubbles when they arise in financial headlines. Notably, though, Fisher Investments UK reviews of data have shown that there is a counter-indicative sign of bubbles for investors to be aware of, too: when headlines warning about bubbles proliferate, we think that suggests sentiment isn’t euphoric – the negative attention tends to be self-deflating. Go back to Templeton’s description of bull markets’ sentiment cycle: prevalent scepticism implies investors aren’t irrationally exuberant about owning equities, which is a key bubble ingredient.

Gauging sentiment against reality is more art than science, in our experience, taking discipline and continual attention. But Fisher Investments UK thinks it is useful for tracking whether a bubble is forming or not.

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