In my experience, the financial markets are NEVER fairly valued nor at an equilibrium of any kind, but rather we just seem to experience a series of prolonged bubbles, with occasional corrections.
I would define a bubble as a rapid (> 100 percent) rise in an asset class over a reasonably short period (less than year), and eventually followed by a material correction (over 50 percent) in a similar time frame (less than year) as its ascent.
Although I don’t have a thesis as to why bubbles materialize and persist for so long, my assumption is that they arise due to our prevailing market structure, where there are largely passive investors and very little oversight.
In every year, there is always an asset class that appears to be out of line with the overall market trend, and there have been many such instances in recent memory.
Analysis
Shanghai A-Shares - 2015
Over the opening months of 2015, the Shanghai Stock Index climbed by 150 percent, and reached a record peak of 5,000 in June of 2015, only to see 40 percent of its valuation drop in less than a month. The bubble that emerged in A-shares was largely a functin of policies announced within their 13th five year plan (FYP), which encouraged the development of domestic financial services industry, and created huge speculative activity. The collapse, however, was faciliated by tightening of margin financing on stock trading, so as to prevent further speculation in the markets. In retrospect, the A-share market euphoria was a very short-lived and has had long-term impact on the confidence of retail investors.
China Property - 2016/2017
On the backdrop of the 2015 A-share collapse, China introduced a variety of initiatives to ease the economic crisis and to discourage overseas investments. As local investors were concerned about a potential devaluation in the RMB, real-estate investment accelerated as it was deemed a more attractive asset to holding cash. Property prices in Shanghai, Beijing, Nanjing and other big cities soared; Shenzhen prices rose by over 60 percent in 2016. By the end of 2017, all the major property developers - Evergrande, Country Garden, R&F, Vanke, Shimao, Agile, and so on - were at record valuations, with the most notable, Evergrande, of $200 billion and a P/E of 47. A few years later, valuations had collapsed over 80 percent.
Hong Kong Exchange and Clearing - 2020
In 2020, the HKEx modified rules to allow for listing of pre-revenue biotechnology companies. There was great euphoria that Hong Kong would emerge as the premium investment destination for bio-tech listings, and that the HKEx would benefit from a long pipeline of IPOs. As I’ve highlighted with investor friends over the years, although a market can have a period of intense market activity (huge trading volumes), its takes years to build out the front-back office capacity to have a sustainable increase in trading volume. The HKEx is frequently a speculative target of the retail investor community, but alas the correction is just as intense as the euphoria.
China Shipping - 2021
During the early stage of COVID in 2020, factory and port closures led to a big reduction in ocean containers, with many remaining in N. America. When U.S stimulated in 2021, container demand soared, with shipping rates increasing 4x to 5x their pre-COVID levels. After a decade of difficult economics, the shipping sector experienced record profits, and their stocks when soaring. Technically, this wasn’t a bubble as its more analogous to a spike in commodity prices; nevertheless, the sector observed an eventual correction.
Magnificent Asia - 2024
I believe that we’re in the midst of an AI bubble in the Japanese technology sector; if you dive into the sector (see article on Magnificent Asia), there are many anomolies, which are inconsistent with the fundamental thesis. Let’s see how this sector responds when the music stops.
Considerations
Although I don’t advocate for trying to predict the end of a bubble, I would strongly advocate for avoiding buying into one. There are very few firms like Amazon that can trade at a huge premium for years. Eventually the party ends.
But, I personally see much opportunity for trading in the vulnerable parts of a bubble. Vulnerable means the second tier stocks (non-index stocks) that are pulled-up due to their linkage with the sector. There have been many EV-related names to have joined the Tesla rally, for instance.
I would highly recommend listening to notable short-sellers, such as Bill Fleckenstein or John Hempton (Bronte Capital), who share experiences of being on the wrong side of 10x increase. An entry position of 20 basis points, and trimming on the way up, is necessary to survive.
No risk it; no biscuit.