How advisers can spot market bubbles

Skyscrapers and record prices at art auctions can provide clues

May 7, 2018 @ 1:06 pm

By John Waggoner

If there's one sign of just how wary advisers are in this market, it was the Monday kickoff presentation at the 2018 Investments & Wealth Institute Conference: Navigating Economic Uncertainty by Bubble-Spotting.

The speaker, Vikram Mansharamani, a lecturer at Harvard's John A. Paulson School of Engineering and Applied Sciences, drew a big crowd in the cavernous main hall at Nashville's Music City Center. Mr. Mansharamani outlined two reliable indicators that the economy is ripe for bubbles:

• A peak in the stock price of Sotheby's, the venerable art auction house. The company's stock peaked in 1989, when Japanese buyers flooded the art market, paying world-record prices. The Japanese stock market collapsed shortly afterwards. Sotheby's stock soared again in 1999 in the midst of the tech bubble, and again in 2007, on the eve of the financial crisis.

"People who buy art are usually corporate leaders, and when they buy art at a high price, it's because they have confidence in their corporate lens, and when they take their foot off the gas, it's because they see clouds on the horizon," Mr. Mansharamani said. Most recently, we've had Middle Eastern buyers, he said.

Christie's, a rival of Sotheby's, is selling several important paintings this week, he said, and bubble-watchers should pay attention. "When you hear of paintings selling for more than $100 million or higher, setting new records, it's time for caution. Overconfidence is running rampant."

Skyscrapers. Companies tend to build big buildings in boom times, and the boomier the times, the taller the buildings. The Chrysler building and the Empire State buildings were both under construction in 1929. Another boom occurred in 1974 and included the Sears Tower and the World Trade Center, which were finished just in time for a decade of stagflation. Taipei 101 in Taiwan was started in 1999, just as semiconductors peaked.

"Why does this work? These buildings aren't usually built with equity financing, which means there's a bank involved, which means it's a period of easy money," Mr. Mansharamani said.

And often the buildings are unnecessary: "They're a good indicator of speculative juices going wild," he said. "There's chest-thumping hubris as well as overconfidence of lenders."

Want to know where the next tallest towers will be? Go to The biggest skyscraper currently under construction? Dubai Creek Tower, which will be more than a kilometer high.

During periods of high prices and frothiness, advisers have to choose whether to err on the side of caution or enthusiasm. "We all make mistakes, and in the investment business we're more prone to mistakes because we're constantly being asked to make decisions," Mr. Mansharamani said.

In the current atmosphere, it might be better to make errors of omission — such as missing part of a big rally — than errors of commission — such as going over the top as the bubble bursts.

Even in times when bubbles are flourishing, there are opportunities. Where are the current opportunities? Mr. Mansharamani points to two big trends: A growing middle class in the emerging markets, and a resurgent commodity boom. And he said the two trends are intertwined.

The emerging world middle class means, in simplest terms, that people will be eating more meat. Adding chicken to the pot is one of the first things a family does when it starts to emerge from poverty. That, in turn, means more demand for grain — it takes two pounds of rice to make a pound of chicken. And greater demand for grain means greater demand for fertilizer. Morocco and the Western Sahara have 75% of the world's phosphate, an important ingredient in fertilizer.

Western eating habits tend to mean Western diseases, such as heart failure and diabetes, which in turn means greater opportunities for global healthcare, Mr. Mansharamani said. "People spend more money on health care when they have more money in their pockets. They move from having enough for emergency care, to having enough for preventative care.

"One thing is certain: Healthcare compounds as it continues," Mr. Mansharamani said.

People who emerge from poverty also tend to travel more, which increases demand for fossil fuels and, ultimately, for cleaner solutions to fossil fuels, power storage and batteries. China is already moving away from diesel power and toward all-electric vehicles.

Some cryptocurrencies were in a bubble, Mr. Mansharamani said. "You had all the bubble ingredients underway." Some may have use as currencies, or as tokens in smart contracts. "Then there are a whole bunch of these initial coin offerings that have no reason to exist – they are whole massive Ponzi schemes," he said.

The good news: Big bubbles don't happen often, he said, and you should be leery of trying to time the market. Bubble-watching is "more of worrying logic than acting logic," Mr. Mansharamani said.


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