Share prices, crypto "currencies" at record highs - a new bubble?

Back in January and February 2021, we analyzed the future return prospects of the sharp rise in share prices up to that point and came to the conclusion that the global stock markets still have moderate upside potential, with the exception of a part of the US stock market (IT sector, Tesla) that was driven by too much euphoria. Since then, most of the major stock markets have continued to rise, with the exception of China, India and Japan. Only the US technology stock index NASDAQ has corrected by 10% in the meantime, but is also close to record levels. Records are always a reason for us to check whether there is a bubble here.

Robert Shiller, who in his books "Irrational Exuberance" (2000) and "Irrational Exuberance II" (2005) correctly predicted both the collapse of technology and internet stocks in spring 2000 and the subprime crisis (collapse of the housing market and mortgage securities in the USA from 2006) and was awarded the Nobel Prize for his predictions, describes speculative bubbles as a hallmark of speculative bubbles:

• a sharp rise in share prices
• the circulation of stories that provide alleged reasons and justifications for the high prices
• a significant number of people who brag about how much money they make on the stock market
• a significant number of people who are envious and angry that they didn't get in
• media coverage that reinforces these trends

These characteristics will apply to share prices (particularly in the technology sector) and crypto "currencies" in 2021.

In our Capital Market Outlook from October 2020 (which you can find here ), we identified two further criteria for a bubble, namely:

• State-desired misbalancing to lure investors into certain forms of investment that they would otherwise not buy (e.g. special depreciation on East German real estate from 1990 to 1994)
• extremely low profitability (e.g. dividend yield on the Japanese stock market in December 1989: 0.4%)
  or the current historically unprecedented low interest rate level for long-term government bonds despite high government debt, i.e. despite a deteriorated credit rating

This time we will show another criterion, namely the existence of more attractive alternative investments. The chart below left shows for the equity markets of the major countries and the eurozone that there were three points in time in the last 51 years when individual (Japan 1989, USA 2021) or several regional equity markets (USA, Japan, Germany 2000) were conspicuously expensive. The term "expensive" only makes sense if the performance of equities is actually very weak in the years following a classification as "expensive". Below right, using the example of the US equity market

The chart shows that the price/cash flow ratio had reached its highest level to date at 19 in 2000. US equities were therefore expensive and the performance over the following 10 years was slightly negative (light blue line, left-hand scale, shown inverse).

In March 2000, the other two stock markets were also expensive (left chart, red oval). No stock market represented an attractive alternative to the other. The performance in the following 10 years was negative in all markets (see chart below left, right group of bars). In 1989, by contrast, only the Japanese stock market was highly valued, with a price/cash flow ratio of 18, which was a record at the time.

However, the stock markets in the USA and Germany in particular were very favorable with values of 7.5 and 5.2 respectively. Accordingly, both stock markets were able to achieve a high annual performance of 18% and 15% p.a. respectively until 1999, while at the same time the world's largest stock market at the end of 1989, namely Japan, which at the time was generally considered to be technologically far superior to the rest of the world, suffered an annual loss of almost 5%. In the years after 1989, the other stock markets were therefore a clear alternative to the Japanese stock market. With regard to the technology-heavy US stock market, the situation back then is certainly comparable to today. This is because - as the previous chart at the bottom left shows - the other equity markets are currently also much cheaper than the conspicuously expensive US market and could therefore represent an alternative. This would justify the classification of US equities as a bubble.

It is now necessary to examine whether only other equity markets are a significantly more attractive alternative investment - in which case it would not yet be a pronounced bubble, as the money cannot migrate to other asset classes - or whether there are other more attractive asset classes.

This was the case in Japan in 1989.

At the end of 1989, the ridiculously low dividend yield in Japan was 0.4%, the lowest ever recorded for a stock market at the time, and more than 5 percentage points below the interest rate on long-term Japanese government bonds. These were therefore a very attractive alternative to Japanese equities (see chart above right). At the beginning of 2000, Japanese dividend yields were still somewhat lower than Japanese bond yields. In the USA and Germany, too, the interest rate level for 10-year government bonds was 5.4 and 3.6 percentage points higher than the respective dividend yields at the beginning of 2000 (top left chart).  

In all cases where equity markets were expensive relative to their own history and relative to other equity markets, namely Japan in 1989 and Japan, USA and Germany in 2000, equities were also less attractive than government bonds. The following charts show that in all cases the performance of equities was negative for 10 years and that of government bonds was positive.

If we apply these findings to the current situation, we come to the following conclusions:

• As in 1989, only one stock market is valued at a record high in 2021 and has by far the highest market value (share of the value of all industrialized country stocks in 1989: Japan 43%, 2021: USA 70%). The narrative behind this overvaluation is also similar in both cases, namely technological superiority.
• Unlike in the four stock market bubbles shown in the two charts above, government bonds are definitely not an alternative to equities in 2021, not even in the US. However, this only means that, as in March 2020, investors will have to return to the equity market quickly after a possible future price collapse. This is because government bonds with poor credit ratings (= high government debt, bottom left chart) and historically unprecedented low interest rates are extremely overvalued, i.e. even in a bubble. When countries are highly indebted (after the Second World War or currently), they push interest rates down mercilessly despite their weak credit rating. If they are doing well again financially (1981), then interest rates may also rise sharply to combat inflation, for example.

Our forecast models support the previous statements for the next 10 years up to 2031. Zero performance can be expected for the US equity market during this period. However, if the massive economic stimulus packages fail to take effect and no rapid recovery in corporate profits is achieved, a moderately negative annual performance can be expected (see chart below).

The normally valued European equity market, here representative of the other equity markets such as Japan and the emerging markets, has significantly better earnings expectations of over 5% p.a. after the corona-related earnings losses have been made up for (see chart below). As the European interest rate level is well below the 1.6% p.a. for US government bonds, the yield advantage of European equities over European bonds will be around 5% p.a. In the USA, on the other hand, equity yields will even be around 1% p.a. below government bond yields, especially as, unlike in Europe, a significant corporate tax increase is planned in the USA. This could hit the particularly expensive technology sector, which has hardly paid any taxes to date, the hardest.

However, if there is a moderate rise in inflation rates, particularly in the second half of the next decade, which the over-indebted countries will hardly be able to combat, the equity market in the USA will also outperform government bonds. Any setback can therefore be used to buy equities, but US equities should be significantly underweighted and the rest of the world overweighted.

A look at the major bubbles of the last 5 decades shows that there is one development that surpasses (almost) everything that history has ever seen, namely the price explosion of crypto "currencies" (see below).

This boom can only be compared to the tulip bulb mania in Holland in the 17th century, where prices increased tenfold in just a few weeks at the end of an astonishing upward trend (see chart below). At its peak, a tulip bulb is said to have been worth the equivalent of an Amsterdam merchant's house.

I had already written a few lines about this absurd development in December last year, but now, after another tripling of the Bitcoin price (not the value, which is still below zero!), the topic fits in with today's outlook.

A currency has two properties that characterize it as such. On the one hand, it can be used to pay, i.e. to carry out transactions, i.e. bitcoins are transferred from the buyer to the seller of a good as part of a transaction. In addition, a currency is a store of value, such as the banknotes under the mattress or an account with a credit balance.

The charts below show that Bitcoin is practically unable to fulfill its payment function and produces enormous costs and a high environmental impact.

Since 2017, between 2.7 and 3.8 transactions per second have been executed in Bitcoin worldwide (top left). This is an infinitesimally small fraction of what is needed. The costs per transaction are also absurdly high (top right). Replacing the world's currencies with Bitcoin is unthinkable for these two reasons alone. In order to maintain this useless system, the electricity consumption of a medium-sized state is now required (bottom left) to confirm a transaction worldwide (takes several minutes, which is very annoying if you want to pay late at night in a restaurant, for example, and completely out of the question in a supermarket) and generate new bitcoins. This is being done with ever-increasing effort in China in particular, but also in Eastern Europe. The electricity therefore comes from dirty coal (China) and moderately safe nuclear power, which is not exactly the ideal of climate protectors. The graphic on the bottom right shows the waste of energy. A transfer transaction with Bitcoin requires 660,000 times as much electricity as if you simply paid with a Visa card, which is also infinitely faster.

Conclusion: Bitcoin will never be able to replace the payment function of a currency.

Is Bitcoin at least suitable as a store of value? Bitcoin advocates claim that there can be a maximum of 21 million Bitcoins due to the algorithm on which it is based and that Bitcoins are therefore scarce and thus a good hedge against inflation. However, if we simply believe that Bitcoins cannot be secretly multiplied, we know that there are now around 9000 crypto "currencies". There has long been massive inflation. One of these "currencies", Dogecoin, was developed in 2013 by software engineers Billy Markus and Jackson Palmer as a satire. It is definitely useless, as both gentlemen have correctly explained, and is not accepted anywhere as a means of payment. Thanks to a few targeted tweets by the dubious Elon Musk, Dogecoin has just reached a market value of 50 billion. One can only advise the Dogecoin disciples to exchange the 50 billion into dollars, euros, gold, shares, real estate and, if you like, savings and fast cars, which unfortunately only a few will succeed in doing.

However, the biggest risk for crypto "currencies" is that politicians are starting to wake up. India is already considering a ban; Turkey, which has significant financial problems, has decided to do so on April 30, 2021. Many other governments will follow suit because they absolutely need direct control over their current currencies to survive. If you look again at the chart on government debt and long-term interest rates (page 3), it is obvious that financially strained countries are using the opportunity to push down interest rates in order to service their debts. In a decentralized currency that is not controlled by any government, such as gold, this is impossible. This is why governments temporarily suspended the gold backing of their currencies at the beginning of the First World War and permanently in 1933 to combat the Great Depression, with the exception of the USA in 1971 to finance the Vietnam War. Since then, it has been possible to create and provide infinite sums of money to combat crises, as the coronavirus crisis has shown. As the financial burdens of all states will tend to increase in the coming decades, particularly due to demographics, states will create their own cryptocurrencies and either regulate private ones to death or ban them.

Conclusion: The tulip bulb was also a store of value for a while until February 3, 1637. However, it then became clear that it can be multiplied at will, just like crypto "currencies". Most crypto "currencies" will end up completely worthless; some that are technically superior to Bitcoin may be able to survive in certain functions - but not as a global currency and certainly not at today's prices. What will certainly remain is blockchain technology, which has already found a number of useful applications outside the currency sector, just as the tulips are still delighting us with their colorful splendor 384 years after the collapse of the tulip bulb mania.