Editor’s note: This article was first published in March 2014; its market context, including the five-year bull market, Nasdaq weakness and hot tech stocks such as Facebook, Groupon and Twitter, is from that time. The predicted crash did not happen as described: US markets saw a correction in August 2015 and kept rising. These March 2014 market forecasts are kept as a historical record. They are not investment advice.
The word “bubble” has turned up in several financial media outlets today, and there’s no shortage of reasons to suspect that a new bubble is close to bursting. In the last 14 years we have seen 2 bubbles burst, and since then Wall Street has been riding what is probably the biggest bull market in its entire history, with 5 straight years of gains and no corrections of any real significance.
A correction is needed, and it may be on its way, with the snag that, in such a strongly bullish trend, investors use any dip as a chance to buy, which keeps prices from falling. But the fear is coming from the Nasdaq, an index that tends to move ahead of the other US indices, whose main components are showing great weakness. Tech stocks are taking the worst beating these days, and that is what is stirring fears of a repeat of the dot-com crash of 2000.
Remember that the dot-com bubble burst once tech company valuations were above 100 times their book value, a situation that is happening again right now with tech stocks such as Facebook, Groupon, Twitter, Amazon and so on.
Technically, with practically every index at all-time highs, many analysts see the possibility that we are only halfway through a bull market that isn’t over yet. The fundamentals, however, are already starting to show stagnating company revenues, and combined with high valuations, this probably means that in the coming quarters valuations won’t square with the disappointment we may find at many listed companies.
When company valuations are high and profits are growing, there’s nothing to worry about, but when high valuations are not backed by an upward trend in profits, the investment may turn out to be a bad deal. Either way, investing on Wall Street at these levels right now is risky. Investing in tech stocks, despite the falls, is extremely risky.
First comes the bear trap
We all know that nowadays you can make money whether the stock market goes up or down, and that possibility is within reach of any retail investor.
No two bubbles are the same, even though all bubbles go through the same phases. But there is something all bubbles have in common: retail bulls lose money, and retail bears don’t usually make any. This time will probably be no different.
Today alone many investors have taken short positions, since signs of a sharp correction are starting to appear. And it’s tempting for anyone to sell their portfolio to avoid losing money, and also to make money from the market’s fall. Going by the way markets have behaved so far, most retail bears tend to fall into bear traps, which basically means taking short positions in anticipation of that correction and then being forced to close them at a loss as the market carries on with its uptrend. That’s when the financial media start talking about the bull market continuing again, and that’s when the strong hands exit en masse and big investors and funds take short positions, usually catching everyone else off guard.
By the time retail investors catch on, most of the bear market they wanted to take advantage of has already gone.
What I mean by this, at the risk of being wrong, is that we will probably see falls followed by further gains. And at some point during those gains, probably over the course of 2014–2015, we may see a major crash on Wall Street, above all in tech stocks, dragging down the indices of practically the whole world with it. And at no point will we know whether that sharp fall is a mere correction (badly needed in the markets) or a big bubble that plunges us back into an even deeper recession.
And the Spanish market?
If there’s one thing I’m sure of, it’s that the IBEX will get back to 15,000 points sooner or later, because the stock market eventually follows its long-term uptrend (except the Nikkei, which has been in a downtrend for decades).
Still, I keep hearing that European shares in general, and Spanish ones in particular, are great investment opportunities because they are the cheapest. And I keep repeating that technically it’s true that they’re the cheapest compared with the prices they once traded at, but on fundamentals they are probably the most expensive, given the low profits and high debt our companies have piled up.
What I have no doubt about is that when a sharp fall comes on Wall Street, or a tech bubble starts to burst, our index will once again touch the lows it reached in 2012, and we will see some of our listed companies disappear as economic weakness is confirmed and they struggle to keep servicing their debt in a dead consumer market.
So let me take this opportunity to remind you that you should be invested in solid companies, and keep your eyes wide open if you hold speculative positions in penny stocks that are hanging by a thread, because if this scenario plays out, Urbas and Quabit (to give an example) wouldn’t survive the next one.
All of this is speculation. If one thing is certain, it’s that the more vigorous the rally, the stronger and bigger the corrections that follow. High valuations at companies whose profits and markets are slowing tend to take their toll in the end. The problem is that nobody knows when the thing we know must happen at some point will actually happen. It could be in summer 2014, in December or 3 years from now, but there are more than enough signs to stay alert.
See also: The 10 commandments of stock market investing
Featured image: Luca Marfè at Italia all'ONU, CC BY 2.0, via Wikimedia Commons.
