What conditions need to be in place for an asset bubble to continue and how that applies to stocks, cryptocurrency, and houses.
Topics covered include:
- How to determine if there is an asset bubble
- What are microbubbles and anti-bubbles
- How the cannabis stock bubble burst
- What is required to sustain an asset bubble
- How the current runup in home prices differs from the housing bubble in the mid-2000s
- What structural changes have led to the high valuations for U.S. stocks
- What is the Great Wealth Transfer and will it impact stock prices
Show Notes
S&P/Case-Shiller CA-San Francisco Home Price Index—Federal Reserve Bank of St. Louis
Yes. It’s a Bubble. So What? by Rob Arnott, Bradford Cornell, and Shane Shepherd—Research Affiliates
What’s really going on with San Francisco Walgreens closures? by Eric Ting—SFGATE
SF ranks high in property crime while it ranks low in arrests by Phil Matier—San Fransisco Chronicle
The Great Wealth Transfer—Cerulli Associates
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Related Episodes
226: How To Spot Asset Bubbles and What To Do About Them
329: Meme Stocks, GameStop, Short Squeezes, and Bubbles
Transcript
Welcome to Money For the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is Episode 365, it’s titled “Why Some Asset Bubbles Don’t Pop.”
San Francisco Bay Area Home Prices
LaPriel and I have spent the last week in the East Bay Area, visiting our son. We have a friend who is a first-time homebuyer here. He recently purchased a modest ranch house in a quiet neighborhood, about 20 miles away from San Francisco. The home was built in 1950; 2 bedrooms, one bath, 900 square feet. He paid over $600,000. $700 a square foot. Is that a bubble price? Not necessarily. Home prices in the East Bay Area are up 11% in the past year. They’re up 30% from the peak in 2006, and double from the bottom of 2012. Home prices fell 39% from 2006 to 2012.
The East Bay Area is incredibly beautiful. They’re not making more of it. There are amazing vistas, great weather, wonderful shops and restaurants, super people. There’s scarcity when it comes to the East Bay Area. San Francisco is also a vibrant city. It has some stresses right now—homelessness, drugs, theft.
I was at Walgreens, a drugstore on Market Street in San Francisco. I needed to buy a $3 box of dental floss. There have been so many thefts at Walgreens in San Francisco they’ve closed 22 stores. This one is still open, but much of the merchandise is under lock and key. I needed to call customer service in order for them to unlock the box of dental floss so I could buy it. San Francisco has the highest per capita property crime of the top 20 cities in the U.S, according to the FBI, yet home prices there have increased 25% in the past year. There is still buying pressure from the marginal buyer that wants to live in San Francisco and the East Bay Area.
What Is Required for an Asset Bubble
Three years ago, in episode 226, we discussed asset bubbles. We focused on cannabis stocks. We looked at the work of Rob Arnott. He’s the founder of Research Affiliates, an investment firm, and a longtime academic. He says, “For a bubble, we need a valuation model that justifies the current price based on implausible assumptions. That there’s no way, little chance, to make a positive return relative to bonds or cash using reasonable cash flow growth assumptions. We need implausible assumptions. An anti-bubble is the opposite—we need implausibly pessimistic assumptions in order to not make money in that asset class.” That’s the first requirement, implausible assumptions.
The second requirement is the marginal buyer doesn’t use valuation models. The marginal buyer, the individual or institution stepping in, willing to pay the current price and providing buying pressure to pay at a higher price—they don’t use valuation models; they believe in some narrative, a story, a meme, expecting to resell the asset to someone in the future at a higher price.
If we look at the prominent bubbles that I have invested through as an institutional investor, the internet stock bubble in the late ’90s into the year 2000, the narrative there was new economy stocks, dot-com. No more brick-and-mortar stores. Everything was going to be online. And that was a narrative that more and more people believed. Random people on the street were recommending their favorite dot-com stock. There was a palpable enthusiasm and a fear of missing out. The housing bubble of 2006—their narrative was home prices can’t go down nationally; they’d never have. There could be general asset bubbles across many different securities, or there could be microbubbles, just a single asset.
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