Disclaimer: Views in this blog do not promote, and are not directly connected to any Legal & General Investment Management (LGIM) product or service. Views are from a range of LGIM investment professionals and do not necessarily reflect the views of LGIM. For investment professionals only.

Plenty of trouble, but no bubble

Could there be a bubble during a crisis?

 

Over the course of my career, I have collected a range of indicators that seek to have some predictive value in spotting the emergence of bubbles. In all modesty, I call this the Heiligenberg Index.

It seems a strange time to be thinking about bubbles: we are still in the midst of a pandemic and economic crisis, to say nothing of escalating geopolitical tensions and apparently complacent market sentiment. But equally, this sangfroid helped US equities produce their best quarter since 1998 and has propelled them back towards their all-time peaks.

So has the recent rally re-inflated the bubble, or did the bear market in the first quarter let out sufficient air?

 

As you can see from the chart, the index is creeping up but it’s not yet at alarming levels. Please note that this doesn’t tell us much about the short-term direction the market may take; it is just an indication that bubbles may be in the early stage of formation.

Playing the market

Some signs of increased “bubbly behaviour” have emerged recently. The most interesting one in my opinion is that new investors are being drawn to the market, for instance through electronic trading platforms, such as ‘Robinhood’ in the US, that do not charge upfront commissions. They have attracted a new crowd of investors: the median age of this new breed of amateur playing the stock market is 31, and the share prices of the companies they’re targeting tend to have crashed, such as car-rental businesses and airlines.

Some people attribute the new-found popularity of these platforms to the lockdown and to a gaming culture. The theory is that people are bored, and where they used to bet on live sports or go to a casino, they are now willing to bet on anything that moves - and stocks have moved plenty. Robinhood also has some features that are often used in gaming to keep people engaged in the stock trading ‘game’.

The area of the market where a bubble is most likely to emerge is, in my view, the technology sector. Beyond the present fad for penny stocks, the sector is likely to attract many of these young, new investors, who are digital natives. They will buy what they know and what they use to live their lives: namely technology, particularly digital- and internet-related stocks.

That said, we remain positive on technology stocks at the moment, as part of a diversified portfolio. We believe this sector has strong potential in a low-growth environment after COVID-19, where technology becomes a strategic industry.

Indeed, bubbles are not necessarily bad for investors. If you can identify them early, you can make money from the formation of the bubble. The skill is to be disciplined: to decide when enough is enough, when the risk of the bubble deflating is becoming too big. We believe we may be years away from that moment, but we will be carefully watching our Heiligenberg Index.

 

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