4 Popular Candidates for the Next Bubble: Kleintop

Bubbles with potentially damaging effects seem to have similar characteristics that can help investors spot them before they burst

Jeffrey Kleintop is on bubble watch.

Kleintop, senior vice president and chief global investment strategist at Charles Schwab, recently posted a commentary, called Where’s the Next Bubble?, that looks at potential bubbles that are worth watching.

According to Kleintop, there are four popular candidates for bubbles based on the questions he gets from investors. Remarkably, he says, none of these seem to fit the “classic profile of a potentially damaging bubble, but that doesn't mean they don't carry risks for investors.”

While sometimes only seen in hindsight, bubbles with potentially damaging effects on the broader markets and economy seem to have some similar characteristics that can help investors spot them before they burst. For instance, past bubbles — like the technology, telecommunications and media stocks of the Nasdaq Composite Index; crude oil; precious metals; and homebuilder stocks in the S&P 500 Homebuilding Index — inflated 1,000% over 10 years before bursting and cutting prices by more than half in the following two years.

According to Kleintop, the 10-year buildup is important to how embedded the bubble becomes in the markets and economy when it bursts.

Here are the four bubble candidates, according to Kleintop:

1. Cryptocurrencies

Bitcoin, which is the most popular cryptocurrency, has surged more than 1,000% in the past two years. It did so much faster than the bubbles that took 10 years to inflate to this level — like the technology, telecommunications and media stocks of the Nasdaq Composite Index or the homebuilder stocks in the S&P 500 Homebuilding Index.

“The shorter amount of time that it took may mean that if bitcoin is a bubble and were to burst it probably won't have as broad of a ripple effect on the economy as the technology or housing bubbles did,” Kleintop says.

2. Volatility

Stock market volatility in the world's major markets is very low.

There are specific products that are tied directly to volatility, and some of these products track the S&P 500 VIX Short-Term Futures Inverse Daily Index, which seeks to reflect the total return for those betting on low volatility for the S&P 500. This index has soared over 800% as it approaches 10 years from the end of the last bull market on Oct. 9, 2007, according to Kleintop.

“While the pattern seems to line up fairly well with prior bubbles, it would look different with a much larger rise and have more time to go until it reaches the 10-year time frame if I shifted the start date to the end of the bear market in March 2009, when volatility last peaked,” he says.

There is also evidence that low volatility doesn’t yet have the “overly optimistic outlook” that is consistent with typical bubbles. Kleintop points to data from the Investment Company Institute that shows individual investors have only become net buyers of stocks in the past 9 months or so.

Given this statistic, Kleintop says that it is possible that the low volatility and steady rise in the markets may have only started to draw more investors to stocks (from cash) and doesn't yet reflect an overly optimistic outlook by investors.

3. Internet Retailers

Only in the past year have the stocks of the dot-com bubble measured by the Nasdaq climbed back above their March 2000 peak, according to Kleintop. He points out, though, that a narrow sub-industry of internet stocks and internet retailers is up well over 1,000% from the low in March 2009.

This small group of stocks make up a slice of the retailing industry within the consumer discretionary sector, which makes it unlike other bubbles.

“The small size of this sub-industry relative to the overall stock market makes it difficult to label its growth a typical bubble and may limit the ripple effect on the broader market were it to crash,” Kleintop says.

This sector is also unlike typical bubbles in that it hasn’t had a purely optimistic outlook. According to Kleintop, these companies have already had a negative impact on the stocks of their traditional retail peers, leaving the overall retailing industry (composed of 10 sub-industries including internet retailers) up a smaller 500% over the same period.

4. Central Bank Assets

“Sometimes investors stretch the definition of a bubble beyond asset prices and use the term to refer to central bank balance sheets bloated by years of buying through quantitative easing programs — suggesting they have the potential to burst and cause broad problems,” Kleintop says.

The combined assets on the balance sheets of the world's major central banks — the Federal Reserve, European Central Bank and Bank of Japan — have grown about 300% over the past 10 years, not the 1,000% of a typical bubble, according to Kleintop.

While the assets on central bank balance sheets may not constitute a classic bubble, Kleintop says that this doesn't mean total debt growth isn't a problem.

“The relentless buildup of debt in the world economy doesn’t fit on a 10-year chart — it's been growing a long, long time — and by well more than 1,000%,” he says, adding that the amount of debt outstanding is “huge” and deeply embedded in the world economy.

However, he says that this global buildup of debt most likely represents a “long-term liability that threatens to exacerbate downturns,” rather than a bubble about to burst.

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