Could Trouble Be Bubbling?

by Andrew Leong
02 Sep 2020

A wealth expert ponders on the dangers of unsustainable stock market growth.

Singapore has entered a technical recession after its economy contracted 41.2 per cent in the second quarter from the previous three months, and dragged down by weak external demand and the COVID-19 circuit breaker measures. However, while the overall global economic data appears sluggish, we have witnessed a few asset classes making new highs – stocks, gold, and Bitcoin. So, the question we want to address this month is, without a solid backup of economic data, are we in danger of having a bubble forming?


The Stock Market

The term ‘bubble’ suggests the possibility of growth that isn’t sustainable. This has been a rising concern as many have observed that the US stock market is surging higher and most investors looking past the pandemic with a firm belief that normalcy is within reach – despite the backdrop of the US averaging more than 1,000 pandemic-related deaths per day.

Nevertheless, the Nasdaq has set a record high, thanks to the amazing performance of the technology stocks. Shares of big tech firms, such as Amazon, Microsoft, Apple and Alphabet, have been surging alongside the new names like Zoom and Tesla. The reason behind their stunning performance is that technology companies tend to be more resilient during a recession because they have better cost structures. They usually also hold large sums of cash on their balance sheets – thus putting them in a better position to weather uncertainties. The massive surge into tech can be illustrated by the success of such companies as Apple, whose market cap have surged to $1.9 trillion at the time of writing. This alone amounts to 85 per cent of the combined market capitalization of the firms that make up the gauge of about 2,000 US small-cap stocks.

Investors have a firm belief in an economic recovery. While they’ve collectively decided that tech will be the best investment to ride the trend, they are not yet ready to invest in areas that are more exposed to the economy, such as financials and energy. Indeed, it sounds contradictory to some extent.

To better understand the likelihood of this being a bubble, a key indicator is how well we are doing on the road to managing the pandemic. Although some noises do exist, we see green shoots of recovery. In early August, we observed that the total unemployment claims dipped to 963,000, well below the estimate of 1.1 million from economists surveyed by Dow Jones. It is the first time that claims for unemployment insurance fell below 1 million since March 21 signalling that the labor market is making progress in its recovery. Vaccine developments have also been reportedly progressing well, with a few teams over the world making breakthroughs in their clinical trials. It is such positive news that has been keeping the general trend up.

So, this begs the question: Are we in a stock bubble? Well, not entirely. The huge liquidity that the Fed is injecting into the system has undoubtedly played a part in the market rally. While we are likely not to see much trend differences on the broad index, we foresee that value rotations are possible to take place, given the uneven recovery in different sectors. The rich valuation in tech stocks could gradually move back to cyclical as investors gain more confidence. This not so much as a bubble popping, but more of reaching a balance.


Gold: Still Some Ways to Go

Gold has been on a strong uptrend since the start of 2020, rising more than 36 per cent to reach its historical high as heightened geopolitical tensions, massive money printing by central banks, and an ultra-low interest rate environment. All these, combined with worries over the economic fallout from the ever-growing number of COVID-19 cases worldwide, buoyed demand for the precious metal.

Looking at the long-term picture, the overall sentiment in the gold space remains very bullish as it thrives in a low-interest-rate environment. It is supported by the central banks’ commitment to keeping interest rates near record lows until the economy recovers from the pandemic, which has led investors to consider seeking gold as an alternative investment to ride out the storm and hedge against inflation and currency debasement.

In terms of our bullish time-frame, we think that the gold rally should be sustainable for months, with the assumption that most of the major upward drivers for gold remain in place, including massive money printing, low-interest rates, and rapid escalation of Sino- US tensions exacerbated by bans on TikTok and WeChat, and the upcoming US elections.

That said, while the precious metal remains on track to continue its uptrend, we could be seeing corrections along the way, such as the ten per cent decline that we witnessed in early August. These corrections are a very healthy sign for the gold market as they allow time for consolidation and present buying opportunities to ride the long-term bullish trend.


Bitcoin: Virtual Gold

Since early March, cryptocurrencies have been on an upwards climb, mostly led by the stable coins (e.g., Bitcoin, Ethereum, Ripple, and Litecoin). Bitcoin surpassed the psychological $10k level and even tested $12k recently. At the time of writing, cryptocurrencies have topped out and pulled back quite a significant bit from their recent highs. This has led to concerns, and crypto bears calling for a huge correction and, some even going further to say that this could be the second popping of crypto’s bubble.

However, to understand if crypto is really in a bubble, we first need to understand the definition of a bubble. According to Economist Hyman P. Minsy, a ‘bubble’ follows five classical patterns: Displacement, boom, euphoria, profit-taking, and, finally, panic. The price movement of a bubble will usually be parabolic in shape with prices showing rapid escalation driven by irrational exuberance. Then, just as quickly as the price rose, a massive sell-off follows causing the burst of the bubble.

This was observed when we saw crypto prices hitting highs in January 2017, and having the massive sell-off ending around Mid- 2018 with drops of 70 per cent from its highs. Fast forward to recent times, prices have somewhat normalized and even the recent decline in August 2020 fell only by 12 per cent. Taking crypto’s similarity to gold, where recent sell-off also happened at the same time where the traditional safe haven declined by about ten per cent, it helps put things into perspective and suggests that the drop of an 11 to 12 per cent magnitude can hardly constitute a ‘bubble’ popping.

Looking forward, with crypto prices normalizing and with traditional institutions taking this new asset class more seriously, we feel cryptocurrency will most definitely be here to stay. The fundamental strategy would then be watching and closely following the bigger and more traded crypto coins, also termed, ‘Stablecoins’. For now, as long as Bitcoin holds above its psychological level of USD$10500/BTC, we can expect BTCUSD to trade higher. Not surprisingly, we might end 2020 above the USD$12000/BTC mark.

Andrew Leong is the COO of Everest Fortune Group Pte Ltd, which currently runs the analysis division of the largest 14 Forex brokers and currency exchange companies in the world. EFG specializes in time-sensitive and actionable technical analysis with a strong focus on key inflexion points.