stock market bubble explained

Another Reason the Stock Market Bubble Continues to Inflate: Inflation Fears

  • Investors believe stocks protect against inflation
  • But zero interest rates support high stock price
  • Can high inflation co-exist with zero interest? 

In previous articles I:

  • Listed the 15 reasons that the stock market bubble continues to inflate
  • Provided behavior finance explanations for the 15 reasons
  • Discussed lessons from Venezuela’s collapse and hyperinflation

In this article, I add a 16th  reason and bring together the thoughts from my previous 3 articles.

 

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15 reasons  the stock market bubble is inflating

  1. Investors believe that vaccines will cure the pandemic quickly, and
  2. Earnings will soar in an economic recovery like no other
  3. The Federal Reserve will support stock and bond markets, dumping $trillions 
  4. Interest rates will remain low, justifying high stock prices.   
  5. Investor greed:  FOMO is fear of missing out
  6. Investor euphoria: Hopium is the drug that gives hope for a bright future
  7. Huge foreign demand for US securities. Foreigners fear the devaluation of their currencies and view the US as “the cleanest dirty shirt in the laundry basket.”
  8. 92 million Millennials believe markets only go up and are actively trading on Robin Hood, Robos, and the like  
  9. The FAANG Stock phenomenon where investors believe mega-companies will perform well regardless of the economy.
  10. Apple is worth $1 trillion and Tesla is worth more than their competitors combined
  11. The election. The stock market is up so far since Joe Biden took office
  12. A belief that amateurs can beat Wall Street with short squeezes on the likes of GameStop and silver. 
  13. Stock buybacks capitalize on low borrowing costs.
  14. SPACs: Special Purpose Acquisition Companies 
  15. IPOs: Initial Public Offerings 

 

10 behavioral biases that explain the 15 reasons: Normal, not rational.

  1. Representative: Fed to the Rescue
  2. Recency: Interest rates will remain low
  3. Hindsight: Fear of missing out (FOMO)
  4. Framing: Economic recovery
  5. Herding: 92 million Millennials are buying
  6. Loss aversion: Vaccine works
  7. Narrative: FAANGs rule
  8. Confirmation: Foreigners are big buyers
  9. Self-attribution: Hopium, the drug that brings hope
  10. Overconfidence: Amateurs can beat Wall Street

 

Inflation fear is a 16th explanation: A lesson from Venezuela

Venezuela’s stock market taught a lesson in 2016 when the Venezuelan stock market performed best in the world, earning 114% versus 13% on the Dow. This event has a direct application to the recent US stock market. According to this Marion West article:

The curious case of the Venezuelan public equities market is a prime example of why it can be misleading to use stock markets as indicators of economic performance. Most economists agree that Venezuela’s economy is in turmoil and that there is no end in sight. The real reason behind the market’s astronomical rise has little to do with ebullient investor sentiment but instead is one of the symptoms of the government’s inflationary monetary policy. In short, owners of the country’s currency protected themselves from the currency’s severe devaluation by exchanging their bolivars for seemingly safer assets, including stocks. With huge volumes of money pouring in, the stock market artificially inflated.

 

Conclusion

There are growing concerns about the stock market and inflation. How high can stock prices rise? How much money can the government print? “Discretion is the better part of valor” sounds like a good mantra to me at this time. What are your thoughts?   

Some of the pumps that inflate the stock market bubble are running out of air. Specifically, the Fed cannot continue a Zero Interest Rate Policy (ZIRP) in the face of serious inflation and has announced that it might permit 2% inflation. Is this really something the Fed permits?