Financial Advisors

Four Causes of the U.S. Stock Market Bubble

  • Investor behaviors are inflating the US stock market bubble, namely hope and greed.
  • Fed intervention is a third cause. It has inflated stock and bond prices, causing money illusion.
  • A fourth cause is increasing foreign demand for US securities.

I’m perplexed by the disconnect between the US stock market and the economy. Why does the stock market keep going up?

Two explanations are common: (1) Hopium is the hope that the recovery will be swift and thorough and (2) FOMO is fear of missing out. In other words, hope and greed. In an earlier article this year I added a third reason – inflation in stock and bond prices caused by Quantitative Easing (QE). And in this article I add a fourth reason to the list – foreigners protecting their savings by holding them in U.S. dollars. 

Foreigners are buying U.S. stocks like never before

Non-US citizens are justifiably concerned that their currencies are being devalued. U.S. investors should be worried too, but the U.S. dollar is the “cleanest dirty shirt in the basket.”  Global pre-COVID per capita debt exceeded $200,000, and it is increasing as central banks around the world print money for COVID relief. Foreigners believe the U.S. dollar will depreciate less than their currencies because it has a history of stability and it is the world’s trade currency, so they are investing in the US dollar by investing in US companies, as shown in the following picture. Most investors are not comfortable trading currencies, AKA Forex.

Exhibit 1: Ownership Breakdown of the US Equity Market

According to Goldman Sachs “Foreign investors bought $187 billion in U.S. equities during the second quarter of 2020, making them the biggest buyers during the recent bear market.”

Sure, U.S. companies are great companies, but the U.S. does not have a monopoly on great companies. The global debt crisis is real and getting worse, so the whole world should expect currency devaluation, with the weakest tumbling first. Hopium and FOMO are passing fancies. The world debt crisis will not go away quickly, but the U.S. may be the last to suffer its full consequences.

Fed intervention has caused inflation in stock prices

Despite $5 trillion in Quantitative Easing (QE), inflation measured by the Consumer Price Index (CPI) has been less than 2%. But the CPI is the wrong measure because most of the QE money has ended up in the U.S. stock and bond markets. Prices of stocks and bonds are inflated, creating money illusion.  COVID relief so far has added $3 trillion, with another $2 trillion likely to follow. Some of this money will move the CPI needle because it is being used to buy groceries. But much of it will buy securities, further inflating the bubbles.

Money printing around the world has fanned the flames of the world debt crisis and driven foreign investors to dollar denominated investments.

A Refresher on the Global Debt Crisis 

Per Capita World Debt Has Surged Above $200,000” is one of my most read articles. It was written in July last year. COVID relief has increased this debt, but let it suffice to say that “the world economy is running on the fumes of delusory borrowed money, playing an outlandish game that will not end well.  Fiat money only works if we all agree to honor it. Otherwise it’s just pieces of paper. US currencies were debased in 1971, when they were taken off of the gold standard and replaced by “In God We Trust.” Now debasing means printing money, or monetizing the debt. Lenders lose when borrowers control payment values.”

The manifestations of the problem are summarized in the following picture:

World Debt Crisis

Submission to the crisis has already begun with the weakest economies like Greece and Venezuela. Citizens of crisis countries try to protect their savings by holding them in U.S. dollars, but this simply postpones the misery because the U.S. also has serious money problems.

Conclusion

I suggest four reasons that are causing a stock market bubble and suspect you can add more. The action step is to protect against the ultimate popping of the bubble with cash substitutes like gold and other alternatives.

The U.S. bond market is also in a bubble through the manipulation of the Fed, so it is not a good place to defend.  “Never fight the Fed” is cute, but not very helpful.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Ron Surz

Ronald J. Surz is Chief investment Officer of Glidepath Wealth Management and President of Target Date Solutions (TDS). GlidePath manages Personalized Target Date Portfolios for individual investors, primarily in IRAs. TDS manages commingled Target Date Funds for 401(k) plans. An industry veteran, Ron started his consulting career with A.G. Becker in the 1970s and formed his own consulting firms in the 1990s. With Masters degrees in Applied Mathematics and Finance, Ron publishes regularly and has developed leading edge technologies like the patented Safe Landing Glide Path® tracked by the SMART Funds® Target Date Index.

Read Ron's Bio