Bubble prerequisites

Chas Craig, BridgeTower Media Newswires

“One of the pregnant lessons of that year will by now be plain: it is that very specific and personal misfortune awaits those who presume to believe that the future is revealed to them.”
– John Kenneth Galbraith, “The Great Crash 1929”

There is a lot of talk of bubbles in markets today. Depending on the purveyor, bubble worries range from cryptocurrencies to the stocks of leading American businesses. In The Great Crash 1929, Mr. Galbraith provides two conditions that make speculative bubbles more likely. Below I summarize the conditions he identified and provide some commentary regarding where I see risks from these conditions being most prevalent today.

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Speculative mood

Speculation that occurred in 1928 and 1929 cannot be easily assigned to low interest rates. In fact, Galbraith noted that “money, by the ordinary tests, was tight in the late twenties.” He posited that far more important than the level of interest rates or supply of credit is a general sense of confidence that regular people are meant to be rich. He further noted that a prerequisite for this speculative mood is a faith in the altruistic intentions of others, “for it is by the agency of others that they will get rich.”

In another recent column discussing pockets of excess and elevated investor enthusiasm, I noted that I had saved the front page of the “Exchange” section of the Jan. 23-24, 2021, edition of The Wall Street Journal where the headline read “Attack of the SPACS.” My thinking, it is reasonably possible that it will be fun to have an artifact of the ensuing craze in Special Purpose Acquisition Companies. With these vehicles, money is raised via the initial public offering of a shell company, which then hunts for a private company to buy. It is an expeditious way for a company to go public, which allows for looser disclosure requirements. While the IPOX SPAC Index is down 13% since my January comments, in general, SPACS seem to be one of the corners of capital markets where the “speculative mood” is in fuller swing. Also, buyers of these vehicles are reliant upon the benevolence and aptitude of the SPAC sponsors, which, in most cases, will still make money on these transactions even if losses to ordinary investors prove steep.

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Plentiful savings

The “House Money Effect” is a theory that seeks to explain the tendency of investors to view investment profits as “house money,” which they redeploy with a higher risk tolerance. For this reason, speculative orgies are more likely to break out at the end of a long period of prosperity and rising securities prices. Indeed, with a few interruptions, most notably in spring 2020, securities prices (most importantly stock prices) have risen dramatically over the past decade plus following the Financial Crisis.

Further, the extraordinary fiscal policy response has more than replaced lost wages from the economic impact of the pandemic, juicing Americans’ aggregate savings rate. Personally, I think a lot of people view stimulus checks and excess unemployment benefits as house money as well. In Galbraith’s words, “If savings are growing rapidly, people will place a lower marginal value on their accumulation; they will be willing to risk some of it against the prospect of a greatly enhanced return.” In this writer’s view, the “House Money Effect” is an underappreciated part of the speculation in cryptocurrencies.

However, there are pockets of excess in almost every market environment; meanwhile, stocks in general tend to increase over time. So, while it is obviously prudent to avoid speculative orgies, it has also been prudent to avoid marketing timing.

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Chas Craig is president of Meliora Capital in Tulsa (www.melcapital.com).