"Booms start with some tie-in to reality, some reason which justifies the increase in asset values, and then -- and this is the critical feature of speculative mood -- the market loses touch with reality" - John Kenneth Galbraith
It was the 1600s and Dutch people were getting richer day by day, thanks to the wealth gained by the foreign trades led by the Dutch East India Company. As more money was pouring in the Dutch empire, more and more people were having disposable incomes in their hands. New upper-middle-class rose and with this interest in luxury items too. One of these items was a flower, Tulip. Tulip is a flower with a rounded and large bulb of bright colour. It was cultivated in the Persian region and brought to Europe in the mid-1500s. It became an exotic flower for the Dutch people, and they used it to bolster their wealth in front of their mansions. It was tough to garden the flower already, and a virus struck the plant which made its bulb more beautiful with fiery patterns, that dubbed with the name ‘Semper Augustus’.
Genetic engineering would not come into existence for the next 200 years. So, the plant getting struck with a virus and getting those fiery patterns was sheer luck. The demand for tulips picked up and Dutch people went into a buying spree. They were ready to pay any sum of money for a tulip bulb. Prices skyrocketed and one could have bought two or three mansions with a single bulb. Tulip craze was like nothing seen before. A time came where people did not even bother to exchange real tulip, but just a contract which bet on the price of the tulip. This was the first instance of derivative trading. Prices of tulip soared to irrational level until February 1637, when this whole mania came to an end. People were not able to cash their contracts with anyone. Prices plummeted and by May 1637 it fell by 99%. World’s first financial bubble burst and people who had invested lost everything and suffered.
Fast forward to future and we saw US 1930s stock bubble, Japan 1980s real estate and stock Bubble, 2000s Dotcom Bubble, US 2008s housing bubble and the recent crypto bubble. In all these people kept on buying the assets, hoping they will get a better return. This anticipation soars the value of the asset to an unprecedented level which could not be justified by any means. The initial investors who ride this wave get into euphoria and those which didn’t invest earlier goes into fear of missing out. In the recent crypto bubble, you would have seen people showing off their hard to believe returns, which tempted others to invest in this asset without proper research and valuation. They took the price of cryptocurrency so high that no more buyers are available at one point, and then this bubble burst again, leaving millions of people in huge losses. In all these bubbles there is one thing common, investors want to make quick money without doing due diligent research about the asset. They kept ignoring the fundamentals and started to think the price will never come down as demand for the asset will remain intact.
Present Stock Market Bubble
On July 31, the US reported the worst quarterly fall in the economy of 33% which is even greater than the 1930s great depression while Dow Jones Industrial Average is just 10% down from its all-time high.
Another bubble is in making and this time it is different, bigger than ever and will be worse than ever. Because of Covid-19, nations across the globe are in lockdown with bare minimum economic activities to contain the spread of the virus. GDPs are falling at an unparalleled rate, people are losing their jobs, companies are going bankrupt and still, the stock markets are trading near their highest. Stock markets were used to be the reflection of the economy, but today the divergence of the economy and the stock market is huge. On July 31, the US reported the worst quarterly fall in the economy of 33% which is even greater than the 1930s great depression while Dow Jones Industrial Average is just 10% down from its all-time high. India is following the same streak, our economy was already feeble by the blow of demonetisation and ill GST implementation, and COVID-19 made it worst and to the contrary, the stock market is trading near its all-time high of 12400.
Governments these days are facing a huge backlash from the lockdown across the globe. They are short of revenue and concurrently, facing the pressure to revive the economy. Especially the Trump government as his actions didn’t perform well and US elections are pending in November 2020. In March he announced a relief package of $2 trillion US dollars for the revival of the US government. Simultaneously, the US Federal Bank started its quantitative easing by announcing that it will buy corporate bonds and ETFs and reduced the lending rate for the banks to 0%. These measures together have generated huge liquidity in the US market. The US enjoys a superior position in the world where it can print as much money as it wants. US dollar is a reserve currency and demands of it never diminish. So, the US gets away with the problem of Inflation. If it had have been done by any other country they would have faced hyperinflation by now but for the US this liquidity infusion is providing easy excess to money for the US corporations, which are soaring the prices of their stocks.
Retailer in the Stock Market
The stimulus money provided to the US individual by the largest US relief package is being used to speculate in the stock market. The company Yodlee, which surveys the US spending behaviour, saw a rise in the stock spending of a US individual, who got Corona relief money, as much as 93%. They are putting the money in stocks which were provided to them for their sustenance.
In India, from the past many months the big funds houses and foreign and domestic institutional investors are pulling their money back from the stock market to place that money into safer heavens. While the individuals, retail investors, who before lockdown otherwise were busy with daily chores of business or offices, are jumping into the market for easy gains. According to the CNBC, from march to July 30 million new Demat accounts have been opened by the retail investors and retail’s daily market turnover has increased to Rs. 56,000 crores from Rs. 30,000 crores. Deliveries of the stocks are at all times low, while the prices are increasing daily. Retail investors are even betting on the dusted and penny stocks like Rcom, Ruchi Infras, Birla Tyres, etc. They have soared 6 to 7 times on an average in the period between March and July 2020. Benchmark Indices, Nifty and Sensex, are supported by just two or three big stocks like Reliance and HDFC and gives a mirage to retails that market are forward-looking and nothing can go bad. These investors are giving a good way out for the big fund houses and institutional investors and without them, the market will not be sustained for long on the so-called dumb money.
Conclusion
This will have a ripple effect on the globe where the new inexperienced investors will start panic-selling and will drive entire markets to the extreme south.
The free lending rate and buying of even junk bonds by the FED have inflated the markets where it will not sustain for long. In future US government will run out of money where it will be no longer be able to sustain the markets. This will have a ripple effect on the globe where the new inexperienced investors will start panic-selling and will drive entire markets to the extreme south. The inflated bubble of the stock market will burst and leave many with deep losses that will not recover for ages. The irony of these times is that big investors, Warren Buffett, are sitting on the huge cash pile, according to some reports he has parked around $140 million dollars in liquid assets and is waiting for a good opportunity, while the new economic pundits in the market are buying wildly. They are literally transferring their money in the hands of already rich individuals in the hope to gain from the market, and then people complain about income inequality. This will end and the bubble will burst. When? Nobody knows, but surely it will.
Fin.
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Disclaimer: Investing is a tedious task. This article is only for educational purpose and I am no one to suggest any investing ideas. Please do your due diligent research or ask your financial advisor before investing in any asset class. You can find sources of this article on my linkedIn profile. Feel free to DM me.
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