While it is certainly true that you cannot verify that something is a bubble until after the fact, you can certainly make an educated guess. A number of factors, such as low interest rates, excessive leverage, and the fear of missing out often accompany the formation of bubbles that occur in almost every recorded historical situation. Today, there appear to be five major bubbles, three of which have popped, one of which is slowly deflating, and one that has yet to come down significantly in price. Bitcoin and cannabis stocks have definitely started to pop, with Bitcoin being the most…
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While it is certainly true that you cannot verify that something is a bubble until after the fact, you can certainly make an educated guess. A number of factors, such as low interest rates, excessive leverage, and the fear of missing out often accompany the formation of bubbles that occur in almost every recorded historical situation.
Today, there appear to be five major bubbles, three of which have popped, one of which is slowly deflating, and one that has yet to come down significantly in price. Bitcoin and cannabis stocks have definitely started to pop, with Bitcoin being the most significant of the two.
Bitcoin has come down substantially from its highs earlier this year. At the time, anything related to the asset, whether it was a company deciding to focus on blockchain or any of the hundreds of similar coins, went up in lockstep. Beyond the belief in the technology and the product, nothing of real value underlays Bitcoin’s huge run-up in value.
Stocks that were even related to blockchain like Hive Blockchain Technologies (TSXV:HIVE) have come off considerably over the past year. This company is a proxy for cryptocurrencies since it operates as a commercial crypto miner. It currently trades at an attractive price-to-earnings ratio of 3.7 and a price-to-book of 0.5. It also is currently debt free with a significant amount of cash on hand.
A downside to the stock is the fact it has been issuing a fair number of shares over the last year. This has diluted shareholders, although it could be argued that the share issuance was a good way for the company to raise cash when cryptocurrencies were on a tear. If you believe there will be a resurgence in Bitcoin, Hive could be a good way to get in on the action, although this would be speculation at best.
Cannabis stocks have also come down significantly in price. The move towards legalization made the companies highly speculative. The problem with the assets was the valuations. Very few of these companies, regardless of their huge percentages of growth, actually made, or even now make, any money. This fact makes it hard for any true investor looking for a measure of fundamental value to seriously consider these as investments at the present time. When the prices started coming off, the speculators began to jump ship.
One debatable bubble is that of inflated prices in dividend stocks. Here low interest rates had a strange effect on these companies, an effect that has less to do with the ability to borrow than the ability to save. When GICs were offering historically low rates of interest below 1%, retirees and people looking for income had to go somewhere to get yield. Dividend stocks, due to their business stability, got massively inflated. These companies began to trade at growth stock valuations. When rates began to rise, the bubble collapsed, leaving dividend stocks at attractive prices.
There is one bubble that is more dangerous than all others, however, that still exists. This is the global real estate bubble. Decreased rates have caused this particular asset class to go up substantially around the world, driving rental yields to historical lows, particularly in larger centres. While real estate price growth has slowed or even come down a degree, it still sits at very high price-to-rent valuations. If these prices collapse the world will be in a dark place. If you fear this bubble may be about to burst, it might be a good idea to avoid smaller banks and REITs.
Investors need to consider historical asset valuations if they want to stay out of trouble. Even with the pullback in global stock markets equities, especially technology, are still very expensive. Real estate is most likely a ticking time bomb.
While bubbles are difficult to confirm before they pop, it is possible to make an educated judgement on downside versus upside risk. The good news is that, as in the recent case of dividend stocks, deals tend pour out of a burst bubble like candy from a pinata.
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Fool contributor Kris Knutson has no position in any of the stocks mentioned.