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Is the Risk-Asset “Bubble About to Pop”?

Robert Prechter's 2020 edition of Conquer the Crash has a section titled "Financial Values Can Disappear." Here's an excerpt:

People seem to take for granted that financial values can be created endlessly seemingly out of nowhere and pile up to the moon. Turn the direction around and mention that financial values can disappear into nowhere, and they insist that it is not possible. "The money has to go somewhere... It just moves from stocks to bonds to money funds... It never goes away... For every buyer, there is a seller, so the money just changes hands." That is true of the money, just as it was all the way up, but it's not true of the values, which changed all the way up and can change all the way down.

Asset prices rise not because of "buying" per se, because for every buyer, there is a seller. They rise because those transacting simply agree that their prices should be higher. All that everyone else -- including those who own some of that asset and those who do not -- need do is nothing. Conversely, for prices of assets to fall, it takes only one seller and one buyer to agree that the former value of an asset was too high. If no other active bids or asks are competing with that buyer and seller's price, then the value of the asset falls, and it falls for everyone who owns it. If a million other people own it, then their net worth goes down even though they did nothing. Two investors made it happen by transacting, and the rest of the investors and all non-investors made it happen by choosing not to disagree with their price. financial values can disappear through a decrease in prices for any type of investment asset, including bonds, stocks, commodities, properties and cryptocurrencies.

As we enter 2021, are financial values on the cusp of disappearing?

Well, a Jan. 14 New York Times article tackles that question. Here's the headline, sub-headline and an excerpt:

A Rally That Won't Stop or a Bubble About to Pop

Stock market sentiment and valuations are high, and with bonds expensive, too, there may be few safe places to turn.

After a volatile yet profitable 2020, Wall Street is hoping for a calm -- and still profitable -- 2021. Not just hoping. Expecting.

Sentiment measures suggest that investors have seldom been more certain that share prices will rise. Excitement for what the year may bring explains why stock valuations are so high.

But is that justified? Or are these the sorts of extremes that indicate a bubble ripe for popping?

The economy and earnings are thawing from the deep freeze they were put in to control the coronavirus pandemic, and vaccines created faster than was thought possible are being distributed. But the impact of the pandemic may linger and change life in unforeseen ways, and at some point, the trillions of dollars of debt issued to prop up the economy will have to be reckoned with. And while the recent ratcheting up of political discord since the election has not slowed the rally in stocks, it may yet produce economic and societal consequences that erode confidence in the markets or in the United States as an investment destination generally.

One ominous development is that as stocks have soared in value, so have alternatives like government bonds. That could leave few places to hide for investors who decide that stocks are exorbitantly priced. The world may become safer, but the markets may be more perilous.

"In no case can you argue that U.S. stocks are cheap," said Meb Faber, chief investment officer of Cambria Investment Management.

How expensive is the market? Very, based on a variety of measures. Earlier this month, it was worth 1.86 times the size of the economy, for example, well above any figure before the last few weeks.

"These things can go far further than anyone would expect because they tend to be self-reinforcing," Mr. Faber said. "The problem with markets is the more expensive they get, the more chance there is that they'll have big, fat losses."

For 2020, the fourth quarter especially, the gains were big and fat. The S&P 500 rose 11.7 percent in the quarter, leaving it 67.9 percent above the March 23 bottom. The index rose 16.3 percent for all of 2020, a year in which economic output is estimated to have contracted 3.5 percent and earnings 15 percent, according to Bank of America.

Some investment advisers find the elevated valuations worrisome; others are comfortable with them.

Jeremy Grantham, long-term investment strategist at GMO, contends that stocks are in a "fully fledged epic bubble." In a commentary published on his firm's website, he highlighted the market's "extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behavior," and predicted that "this event will be recorded as one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000."