George B. from Vancouver, WA asks: Hello Mitch, I’m writing to ask you about the possibility of market bubbles. It feels like everywhere I look, there are stocks up 100%, 200%, even 300% from the bottom. This is particularly in tech and companies like Tesla. What are your thoughts on this whole thing bursting?
Mitch’s Response:
Thanks for emailing, George. You’re not alone in your concern about bubbles – I think many people are wondering if the market is running too hot, and if some reckoning is just around the corner.
In order to avoid burying the lead, let me say this first – these are the very times when owning a diversified portfolio of stocks makes the most sense, in my view. Because I’m in agreement with you – there are many, highly overvalued stocks, and an excess amount of liquidity is bidding up stock prices. But that does not necessarily imply bearish conditions are ahead for the entire market.
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Let’s take Tesla for example, from your question. Tesla is trading at sky-high valuation, making it the fifth most valuable company in the United States. But if Tesla were to disappear tomorrow from the face of the Earth, and its stock price plummeted to $0 in the process, I seriously doubt it would even create a ripple in the broader economy. Tesla is a rapidly growing company with enormous potential, but its operations are still very small relative to the economy (and even the auto industry). Tesla is not intertwined critically the entire global economy, and in fact, many competitors would be happy to see the company gone.2
Hopefully you’re seeing my point here. Bubbles may exist for individual companies, and probably several sub-sectors and sub-industries. But if some bubbles burst here and there, the biggest losers would be the companies and investors who have made major capital commitments to the companies. Bubbles get bad when companies overinvest, investors take on major debt to finance long-shots, and/or banks extend too much in financing companies’ operations. I’m not sure we’re seeing any of these conditions today.
One factor to consider going forward, I think, is whether some bubbles bursting could drag on sentiment. A crash of some kind could give the feeling that something has gone awry with the economic recovery, and it could create a sense of fear or panic – which could hurt spending. I see this possibility as only a short-term risk in 2021, however, because we still have a backdrop of mass immunization in the months ahead and a return to economic normalcy. Seeing some bubbles burst here and there may actually give people the sense that it was only a matter of time – not a sign that something bigger is wrong.
At the end of the day, when I look at the broad market, I do see some cases of what appear to be bubble stocks, but I don’t see a bubble in the broader market and the economy. That’s why I think it’s smart to remain diversified.
Market bubbles form and you never know if or when they are going to burst. While we may not know how the market will be affected long-term, knowing your net worth can be critical to your financial well-being and can help you prepare for what’s ahead. If you do not currently know your net worth, then now may be a great time to calculate it.
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