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Every week, Kyle Caldwell and guests take a look at how the biggest stories and emerging trends could affect your investments, with practical tips and ideas to help you navigate your way through. Join the conversation, tell us what you want us to talk about or send us a question to OTM@ii.co.uk. Visit www.ii.co.uk for more investment insight and ideas.
Hello and welcome back to On the Money, our show looking at how to make the most out of your savings and your investments. I'm Dave Baxter. I'm the senior fund content specialist here at ii and I'm delighted to be in the hosting chair for the first time. We're gonna tackle a pretty big topic today that is market bubbles. Are we in a bubble or more than one?
Dave Baxter:What kind of indicators might tell us whether we're in that? And most importantly for me, as an investor, can you actually do if we're in a bubble? We have a really great guest with us today. That's Michael Browne, investment strategist at Franklin Templeton. Michael has been in the investment space for several decades.
Dave Baxter:He's seen many a market boom, many a market bust, many a market cycle, and should be able hopefully to share some really great insights on this, you know, quite meaty topic.
Michael Browne:Been been through a few days. Thank you very much indeed. Yeah, no thanks for that. I think it's a great topic and I think it's really really interesting because as you say, if you hang around the markets long enough, you'll do two or three of these.
Dave Baxter:Yeah. So let's obviously there's lots of nuance that we will get into. Yeah. But let's let's kick off with the big question. Do you think when we come to AI, when come to stock markets in general, that we're in a bubble at the minute and what is your rationale either way?
Michael Browne:So I don't think we're in a bubble at the minute. It could develop. It's not impossible for it to develop and I think this is where we have to kind of have a thought process as to what is a bubble and what isn't a bubble. Yeah. And is what's the thing that's a notch below a bubble because we have lots of those and and that's a boom.
Michael Browne:So so if you think about it, we go from enthusiasm to boom, boom to bubble, then you can start to think of what is that differentiating factors between between boom and bubble. Lots and lots of booms happen. One of my favorite ones which went completely unnoticed is the oil and gas capex boom of 2010 to 2014, which by the way dwarfs anything that's going on in AI at that moment in time. We're talking a trillion a year, trillion and a half a year over a four year period. So, but we didn't notice that because that was a boom in that in that particular industry.
Michael Browne:You can go out and find those. So that's a really good example when a boom doesn't become a bubble. A bubble is when you've got to have that all encompassing, all focusing exuberance and and the way and and maybe we'll get into this in a bit, I just I define a bubble, it's got to be money, mania and markets.
Dave Baxter:So obviously, it's very difficult to I suppose tell when we're in a bubble and there are perhaps different indicators. I was thinking before this, you might have quantitative things. So for example, I was reading up on, you know, the AI bubble discussion beforehand and people were citing the fact that if you look at things like price earnings ratios in the max seven, it looks much less Doesn't look too bad, doesn't it? Less challenging than for example before the.com.
Michael Browne:Absolutely. It's about half the rate at the present moment in time.
Dave Baxter:Yeah. But also, I suppose you have more qualitative kind of indicators. So this might be general sentiment. This might be the order dodge about, you know, getting into a cab and having the taxi driver recommend stock picks to you and that kind of thing, which admittedly is a bit patronizing towards taxi drivers. But yeah, what kind
Michael Browne:of We're to have robo taxis.
Dave Baxter:Yes. It's already a challenging time. But yeah, what kind of indicators do you look at when you're trying to, you know, make a call on this?
Michael Browne:So so let's let's look at what has to be in place for us to move. And again, let's let's hold that idea of moving from a bubble for you have to go from a boom to a bubble. Let's hold that concept in in place. So first of all, you need obviously an ample supply of liquidity in the markets. It's absolutely, absolutely critical.
Michael Browne:So you'll be at a period where interest rates will be at a low or will be smolched around a fairly simple, if you like, and stagnated at a level for quite a long period of time. So that's an element of confidence in the lending markets, elephant's confidence in the in the banking phase, that you probably have got quite low default rates at that moment in time. So the liquidity conditions are good. I mean, don't have to be wildly fantastic, they're just good. Alright?
Michael Browne:Then I think you have to look at this word mania and this is what say. So first of all, we've got that money piece, it's in there, we know we've got plenty of liquidity and there's some great some great examples in history. Actually, there's a great one from Germany in 1871 which led to the crash in 1873, which is they got 5,000,000,000 in gold from France as part of war reparations, the eighteen seventy war, and that then went straight into the system with liquidity. So great example of a bubble being created by external cash coming into in into an into an economy. So you need that cash.
Michael Browne:Right? That's the first thing. Then you need mania. Right? Now the main what is what is mania?
Michael Browne:Right? You need that sense of elevated extreme changes in mood, where people are rushing around getting very excited about things, and if it drops 6% on a day, they get very disappointed by that. So you have that really big swings in mood. As you write, it starts to catch a wider attention. It starts to catch the attention of the wider population.
Dave Baxter:So do you not think we've kind of reached that point with stocks like Nvidia? I mean, Nvidia already has like huge expectations every time a trading update rolls around and you can have quite big moves. Even if they actually satisfy or exceed expectations, you can have big drops and so on.
Michael Browne:Well, that's where I would take that definition a little bit further. Okay. So I I think, yes, people know about it. We have to be careful in our industry, if you like, does yeah, is it talked about on the clapping omnibus, if I can use a different transportation expression about normal people, as opposed to what we're doing, is talking about something because it's part of our daily lives, it's become dominant in indexes, etcetera, etcetera, etcetera. So what I what I would look for is a sense almost of of high energy and social bonding, where you become part of a club.
Michael Browne:You become part of a you feel you're part of that exclusive club where you're onto something and other people are not onto something. That's part of that mania, that over enthusiastic, almost as if you're a football supporter and you're, you know, you you travel anywhere to see your club play. That's the kind of excitement that I'm looking for to see in people and see in investors, and that starts to attract a much broader base of investors than the normal ones. And that's why I think it's really interesting. Think we have to be clever today about it.
Michael Browne:If you if you've, have a look at Andrew Sorkin put out his book on the Wall Street Crash just before Christmas. Really, really good book because he's got lots of social detail in there. And you put it with Galbraith's great tome, then you'd have the whole thing put together. But it's that element of, oh, we're still on the street corners and we watch the ticket tapes and we watch the prices coming out. Oh, I'm part of the club.
Michael Browne:I'm standing on the street corner. I'm doing it. That's the kind of atmosphere that I'd want to get. And I think where we see that today is obviously on social media. And when you can find those sort of clubs coming through and that sort of I'm part of the gang and I'm part of the team sort of sense on social media, that's where to look at it in terms of where we are.
Michael Browne:Now are we there at this point in time? No, don't think we are. I think we are in other assets, but I don't think we are in stocks.
Dave Baxter:So what other assets do you think we've kind of hit that point with?
Michael Browne:Well, we have the great unregulated asset of crypto, and I really think we we've seen some of the elements there. There are other elements in there by the way which really resonate from my point of view going back over history in in in that area because a part of how we recognize that the bubble is bursting is to think about fraud. There will always be frauds in these things. Mean, there's always been frauds all the way through these elements. I've kind of brought it in a bit early, but you know, there's quite a lot of fraud in those particular areas because it's a completely unregulated market.
Dave Baxter:Mhmm.
Michael Browne:So so how do we avoid frauds? You can't in these circumstances, there will be people who will do that and and spotting that and spotting and understanding that first failure and that first fraud is a key point in terms of finding somebody who's taken advantage through inappropriate means of that mania that you're experiencing.
Dave Baxter:Yeah. So let's turn to another asset. Obviously, sometimes people are now kind of comparing crypto Yeah. With it, which is perhaps a different conversation entirely. But you know, last year, actually last two years Yeah.
Dave Baxter:We've seen the gold price Yeah. Surge enormously and unfortunately, we've had more kind of geopolitical strife and very kind of worrying development so far in 2020 Once again, we've seen kind of record highs being breached with gold, with silver, and so on. Where do you stand on the kind of conversation that's been ongoing about gold being in a bubble?
Michael Browne:I gold gold is a really interesting asset. First of all, it's been around forever. It's been a valuable asset forever. And this has got what? Five, six, seven thousand years of history in terms of being worth something and people's regarded as valuable.
Michael Browne:So you're dealing with something that is is always part of your psyche, your monetary psyche. So does it have value? Yes, gold does have value. That makes it different. It has the longevity to prove that it has value, but that doesn't mean to say that you can't have a bubble in an asset such as gold.
Michael Browne:And the way I would look at gold is inflation adjusted. So for years, you know, from from from the mid nineteen eighties where again gold price was really propelled by trouble in The Middle East and wars, etcetera. From mid nineteen mid to late nineteen eighties to to really four or five years ago, the gold price was falling in real terms over that period's time, even though the price was still accumulating. Then you have this extraordinary spike upwards over the last couple of years. So something must have changed in the demand patterns for gold.
Michael Browne:It can't just then for people who have come along with leverage, I'd love to know how much leverage there is in everybody's gold purchase at this point in time, how much the brokers are offering you to, in terms of debt, to buy gold. But that element there is probably there was an element of catch up undoubtedly in terms of the real price of gold. Has it gone too far too fast? Well I think anybody with with with an iota of market history in their minds would say it probably has. Will it still retain a value at the end of this?
Michael Browne:Yes, it will. And that's why I think gold's a little bit more difficult difficult. You know, we have that sense of our monetary systems used to be linked to gold. Silver, I think, is less so. Silver is a market that has that has since it was demonetised a hundred and fifty years ago, is an asset that is prone to speculation, and we've seen people over time trying to corner the silver markets on several different occasions.
Dave Baxter:Yeah. I suppose one kind of related point is, you know, we talk about gold doing very well, we talk about AI stocks doing very well, crypto and so on. If we look at this more widely, last year was quite interesting because it was, you know, pretty much an everything rally. You know, maybe you have things like Indian equities struggle, but most assets, most markets
Michael Browne:There's quite a high degree of correlation across assets, yes.
Dave Baxter:Yeah. So even if we're not in a bubble, I mean, kind of what does that mean for investors and, do we need to kind of on the side of caution there?
Michael Browne:So let's put that in from an equity point of view, let's put that into context. Right? We had the biggest single year of mutual fund equity outflows in The United States since this millennium last year.
Dave Baxter:Mhmm.
Michael Browne:So we have stock prices rising at the same time as US investors took an awful lot of money out, more than they'd ever taken before, and sat on it.
Dave Baxter:Mhmm.
Michael Browne:So there's something else that's going on here again. And and, you know, in local terms, most indices weren't very far apart. But obviously in dollar terms because of the weakness of the dollar against the euro, and other currencies, clearly that differential became much greater, and of course, it's the first year what for eight eight or '9, I can't remember exactly where how many years where non US equities outperformed US equities because of that because of that dollar differential.
Dave Baxter:I think it was the first time in twenty five years.
Michael Browne:Exactly. It's a very long
Dave Baxter:US underperformed all of the major indices basically.
Michael Browne:Yeah. So, you know, we have that situation and that's current that's currency related rather than if you like local value related. But yes, you're right. It was a very broad based mid teens ish sort of rally across equity markets as a whole. And the reason for that I think is pretty straightforward is that the conditions at the moment are quite benign, they're quite resilient.
Michael Browne:We can argue that are we at the start of a cycle rather than at the end of the cycle. I think that's a really interesting discussion, because, I think a number of factors that will play that particular way. And and the AI story, we can clearly see it's now having a genuine effect on profitability. The final piece is that, you know, the amount of equities that we have is shrinking, not expanding at this point in time. We've had poor M and A markets for poor IPO markets for several years now.
Michael Browne:We've had private equity obviously coming into the market and purchasing what they think is really cheap assets, they can't release it back in, but that's fine. So we actually have an equity diminution rather than expansion. Yeah. And what breaks to change that particular process? Maybe it will break this year with a number of IPOs, some very high profile ones scheduled.
Dave Baxter:SpaceX and so on.
Michael Browne:Yeah, SpaceX, ChatGPT, I mean, know, OpenAI. All of these are almost on the slate at this point in time. Whether they come or not will depend on market conditions and depend, of course, on the price that people can get relative to the valuations they've already paid. But yes, diminution of equity has been a feature, so the markets have been able to withstand quite a big outflow from their mutual fund world, at the same time as rising, and at the same time of course, negative process has been going. So actually, everything is getting scarcer.
Dave Baxter:Mhmm. Yeah. I guess it's interesting, you know, discussing, yeah, whether in a boom, whether in a bubble, the kind of key thing is as an investor, what do you do about it? So I'd like to tackle both of those issues. Perhaps it'd be interesting actually to start with a bubble because when you think about market crashes, also when you think about some kind of big events, think of for example the Brexit vote, Trump in 2016, you could have correctly forecast what would have happened, but markets then didn't exactly behave how you would expect them to.
Dave Baxter:So if say someone disagrees with and they think we are in a bubble, what should they do? Yes.
Michael Browne:Absolutely. So let's do the bubble piece and let's do events as separate because I think they're two separate two separate elements. The way to spot a bubble is or a bubble closing out because I think that's more the question isn't it though? First of all, interest rates are rising. In every single instance of every bubble that I've looked at since 1720, South Sea bubble, rates have been rising.
Michael Browne:So rates started rising in 1928, not 1929, they were rising long time before the market actually peaked. So the first thing is you start to see money taken away. Right? The second thing is you will have one or two businesses associated with that particular mania at that moment in time, which will go bust. They are not auto parts businesses.
Michael Browne:We're looking for for something around the AI space that goes bust. And at that point, it's a really interesting comment that people will make. We'll go, oh, don't worry about that. It's just a bad business model. Really?
Michael Browne:But it's in your section. No. No. It's just a bad business model. In other words, you can feel the tides beginning to turn at that moment in time.
Michael Browne:So people will see it but they will ignore it. You know, it is just as an aside, it's amusing Jamie Dimon made his cockroach comment last year. And Greenspan made the irrational exuberance comment in 12/02/1996. That was a four three or we could argue almost four years before the markets peaked out. So again, indicators like that I think are worth holding.
Michael Browne:But one, rates are going up. Two, somebody goes bust in the sector. So somebody kind of dents the confidence a little bit, but everybody brushes over it. Three, as rates start to go up, that question of leverage in both positions and the businesses starts to have an impact. Businesses want more capital, they need some more capital to continue going for its forward because they will be debt laden.
Michael Browne:This is the traditional way. It's gonna be different with AI because there's a lot of cash in this business. But there were debt laden businesses who can't start coming to markets for injections of capital and they will struggle to get some away. So there'll be another early indicator, oh, that issue didn't get so done so well, it's left a bit with the underwriters. Oh, but it's, you know, it's fine.
Michael Browne:They'll have the next trading results. You'll hear all of that. Then you will start to see the market unravel When the market starts to unravel and you get reverse reverse velocity, it's when the leverage comes out. We saw this with Bitcoin on the October 19. Suddenly, realised a lot of people lent a lot of money against a lot of Bitcoin positions and they were forced to liquidate.
Michael Browne:So forced liquidation then becomes your unraveling. Now we're in it then at that point in time, but if you there's one further indicator that I think you would always see here and you'll probably see it before you get to that reverse velocity piece and that's fraud. There will be fraud. There has always been fraud in every single one of these bubbles. So I think there are some really strong indicators.
Michael Browne:If you believe it's a bubble and you see those four factors come through, then you can say, yes, I should be out at this point in time and I need to sit on my hands.
Dave Baxter:Is that the best approach then? I mean, to survive in, you know, a bubble bursting or is it also I mean, how how far does diversification go? You know, what have the kind of approach has been that have served investors well?
Michael Browne:There's there's all there's always diversification and but some of that diversification has to rely on the actions elsewhere. Remember, I'm talking about period when rates are rising, so your diversification into longer term bonds is not going to be there. Okay? You might get some diversification from quality credit corporate debts, so triple being better, high quality credit at the short term, so in the two year level as well. You might get some in terms of cash that would be classic classic holding point and obviously some of the gold buying that we've seen must be as part protection and people are trying to diversify assets and struggling and really running out of diversified assets to hold.
Michael Browne:So there are areas that you can diversify, but you know I can't remember who said it, but the best way to to to understand a bubble is to be involved as somebody once said. And that's why I would prefer to give people a checklist of elements to say, right, this checklist is now coming through. Here are the three or four points
Dave Baxter:Yeah.
Michael Browne:You need to look at, and if you see all of those come together, then yes, I would absolutely sit sit on your hands at this point in time. I'd go to very low risk assets at this point. Are we there? No, we're not.
Dave Baxter:So what kind of low risk assets?
Michael Browne:Well, the I think the key then is going to be dependent on your liability structure. Right? So you're going to have to say if you're a UK investor, you're probably going end up holding as much cash as you possibly can at that point in time within your banking regulatory limits, course, which I think is a £120,000 if I'm right at this particular point in time. So you could move a lot of assets across several different banks and still be protected by the liability schemes and I'm thinking you can hear I'm beginning to think like 2008 again and the risks that people didn't understand they were running in some of the bank's balance sheets at that particular point in time. But that's if you had a real proper bubble, as I said, I don't think we're anywhere near that at this point in time, but if had a real problem, that's how you're going to have to think.
Dave Baxter:Yeah. I suppose then we are running into the classic kind of behavioral problem of if you are sitting on cash, know, missing out on market movements and, you know, when do you actually decide to reinvest and so on?
Michael Browne:Yeah. So so again, we have a again, for for for the individual they have an astonishing range of tools today that they didn't have in 2008. There are I I goodness knows how many short ETFs that you could go to this point in time and you probably should because the best way again of spotting the bottom is actually to be involved in the market. And one of the real things that we've seen about markets over the last few few booms crashes events is how quickly they get to their lows. I mean, March 17 was the low twenty twenty was the low for markets in COVID.
Michael Browne:Right? It was what? A couple three weeks after the Italians had shut the Northern North Of Italy down? It's very, very, very fast moving. Markets fall very quickly and rise slowly, and I think people need to remember that as well.
Dave Baxter:Yeah. Yeah. So any other kind of key lessons you want to share from your rich history of of bubbles, booms, and so on? Any things that investors should bear in mind?
Michael Browne:Well, think I think if you hit money, mania and markets, that's the that's the key piece to go through. Look for if you take those three headings and you think about them and you work with them, your ability to spot the bubble will be will be great. The question is, then you have to also play the game of boom or bubble.
Dave Baxter:And
Michael Browne:and I come back to the point that the oil boom of the early twenty tens, by the way, just after we'd had a great financial crash and apparently there was no money about. Right? No. No. They were able to finance that.
Michael Browne:Absolutely fine. Think about the mobile telephony boom in the late eighties, which culminated really in price terms of Vodafone buying madness management at that particular point in time. That was a boom, but it didn't wasn't a bubble. Think about maybe very close to home, the cable operators boom in the late eighties, the regulator opened up the streets and you could put cables down the streets, etcetera, etcetera. What would we have?
Michael Browne:Eight, nine companies at that point in time to raise capital to do that? We've got one company today because they were never able to make enough money from each individual position to be able to actually justify the capital that was in the ground at that point in time. Yeah. So I would say to investors, you really need to understand what the difference between a boom and a bubble is. Yeah.
Michael Browne:Because your behavior will be completely different. In a boom, that sector becomes off limits, you don't want to get involved in it, but there'll be plenty of other sectors that you do want to get involved in, and you may well have a completely different set of interest rates backdrop, a different interest rate backdrop at that point in time, which will not exist in the bubble moment.
Dave Baxter:Yeah. So stick to your triple m's, or your three m's, look for rates rising, look for things fraud Yes. Debts, that kind of thing.
Michael Browne:Yes. And look for that early company in that sector that's gone busted. Everybody goes, oh, it was just ahead of that busy fund. Right? Everybody brushes off.
Michael Browne:That's a great sign.
Dave Baxter:Yep. Yeah. Okay. Very interesting. Thank you for your time.
Dave Baxter:So no bubble yet, but do keep an eye out on those metrics. Thank you for watching. Thank you for listening, and do catch up with us next Thursday. Take care.