What actually happens when the bubble pops - seeking more experienced users opinions

Just read an article where Jeremy Graham claims we are as the peak of a super bubble that will likely pop when the fed raises interest rates. This isn't the first whale that has warned us of whats coming and most finance professionals seem to agree that the end of the bull run is nigh.

Seeing that i'm 24 years old I haven't fully experienced a recession before especially as a finance professional and i am curious to know how this would affect my job and future as I start full time in July. 

I see a lot of fire and brimstone predictions saying banks will shut down and full economic collapse will be in full force etc but I think people who have invested in real estate, crypto and stocks will see their portfolios wiped out for years and the democratic party will blame trump when Biden doesn't know how to put out the fire thats the full extent I predict. 

So far those of us that can remember 2008 and even 2001 (doubt theres many people from the 80s here), how do you think it will play out?

 

It depends on how badly the stock market falls. A 10 to 20% drop would not have much of an impact.  A 50%+ drop would have a substantial impact. IPOs would probably fall off a cliff because investors would be afraid to invest and companies would lay off lots of people.  I am not predicting any of this, though.

As Pizz said, rising rates would increase borrowing costs and therefore earnings would fall.  Most importantly, my experience tells me that my crystal ball is just as fuzzy of that of the next guy.  

 

Unfortunately, this looks to be a big one. Market breadth has been absolute trash for months. We just broke the S&P 200 day moving average for the first time since the COVID crash. This is a significant long-term technical breakdown that historically signals an accelerating sell-off in the months ahead. The VIX futures curve is in "backwardation" meaning people are betting on prolonged volatility as opposed to a short-term VIX spike like the ones we've occasionally seen since we bottomed out in March 2020. Add to all that a hawkish FED, inflation, and early signs of slowing growth --- it's a pretty horrible "perfect storm" setup. Just my 2 cents. 

 

This is my own ignorance with respect to public markets, but could you elaborate on why it is laughable that margin debt could cause a recession like 2008? I feel like I vaguely remember reading about how one of the triggers in the Great Depression was rampant use of margin causing a cascading effect but I admittedly don't remember for sure and won't pretend to know more than someone who actually works in public markets. 

"The obedient always think of themselves as virtuous rather than cowardly" - Robert A. Wilson | "If you don't have any enemies in life you have never stood up for anything" - Winston Churchill | "It's a testament to the sheer belligerence of the profession that people would rather argue about the 'risk-adjusted returns' of using inferior tooth cleaning methods." - kellycriterion
 

You're right about the Great Depression, but there's an important difference now vs. then.

In the 1920s, there was a direct link between the interbank funding markets and the stockbrokers' call loans - it was basically the equivalent of the modern-day repo market. What that meant was that the solvency and liquidity of all of the systemically important banks were directly tied to the health of the stock market. Banks would lend reserve balances collateralized by equities and expected to be able to "call" these loans back at any time. If these loans were not "callable" and banks had an outstanding balance to settle that day but couldn't, they went out of business. These call loans were basically the interbank funding market.

Today, there is no direct link between the equity market and anything systemically important or any interbank/interdealer funding markets. The analogous kind of problem today would be the UST market blowing up in March 2020 or the ABCP and private-label ABS/MBS repo market breaking down in August 2007 (what bondarb is describing in his thread linked above). There can and will be algo-driven, short-vol related crashes in the equity market, but absolutely nothing will happen to the major dealers and banks aside from some losses in the prime brokerage department (if that). 

Margin debt just means that retail is going to lose a bunch of money speculating in equities - nothing that will imperil the health of the financial plumbing. 

 

See my above comment re: high-frequency economic data showing that we're starting to see demand roll over.

I think the Omicron variant showed that we're starting to see some sanity when it comes to COVID and governments aren't going to continue to shut down the economy over anyone who sneezes anymore. Also, this variant was the most transmissible and the least deadly, whicih tends to be the way that viruses evolve over time.

The supply-chain problems have definitely been impacted via port shutdowns, logistics difficulties exasperated by COVID regulations, etc. but also by a huge shift in consumption away from services and towards goods. As that corrects, and we're starting to see signs of it now, that will significantly relieve the burdens placed on the supply-chain and reduce inflationary pressures.

 
ResiMan

No one has any clue what will happen. Including the people who tell you with extreme confidence what's going to happen.

That is the most correct answer.  There is a lot of strong evidence to suggest that stock prices move randomly, especially in the short run, which is why the vast majority of new money into asset management has been flowing into ETFs and Index Funds for a long time.  The concept of passive investing was not very popular initially when it was introduced in the 60s and 70s.  After all, it seems like common sense that a smart guy should be able to outperform an index.  It is just not that easy to do.  Now, passive investing is very popular.  

 
CollierV

Isn´t this higher rates = Crash talk a bit exaggerated? Not like the Fed is going to raise interest rates to 10%.

Higher rates probably would lead to lower prices but not necessarily a substantial crash.  Another factor to consider is whether or not rate hikes are already built into to current prices.  Fed policy is very transparent, so you would think that all of this is factored into prices but sometimes investors do not behave rationally.  Benjamin Graham, said that in the short term, the market is like a voting machine but in the long term it is like a weighing machine, or something like that.  

One troubling aspect for me is the real estate market, which has skyrocketed, which kind of reminds me a little of 2008.   

 

I am tired of seeing all the "crash predictions". I think people get nervous when the market does "too well". Growth will slow when fed raises rates, but that doesn't mean a black swan crash of 50%+ is coming. Also, not every sector is parallel to each other. Mid cap growth is already in somewhat of a recession. Cathy Woods arkk portfolio has been down 45% over the past year since its peak. I do think the market was over valued due to covid, but I think it's more of a correction rather than a bubble pop. With that being said, all of my growth stocks are showing growing revenues and earnings, so you shouldn't be judging the market based on macro news or whatever. If the companies you invest in are growing and doing well that's all that matters long term. 

 

Not sure when but dot com bubble two will crash, blow up the vc universe with it, capital call lines will blow up as lps change their mind. Equity capital markets dry up, spacs never happen again. Cre will be demolished by office and retail vacancy combined with cap rates doubling, putting a lot of community banks out of business. All crypto goes to zero. Companies that rely on continuously raising equity to exist like Tesla go bankrupt. Pension underfunding and higher interest rates on government debt raises taxes. Stagflation ensues, fed put will not be there. Leveraged funds like annally will blow up with big consequences for the fixed income markets. High speed traders fucked, pay for order flow gone. 

 

All of this can happen at any time. The piece you're missing is the externality of government intervention. If COVID happened 60 years ago, we would have seen Depression 2.0 - government and Fed policies and encouragement to banks (so that they wouldn't pull revolvers, etc.) kept the economy afloat artificially until the actual economy came back.

 

You’re dead wrong on this.

I am old enough to remember watching CNBC every day in 1999 when I was in undergrad and every single day 50% of the talk was “this market is crazy overvalued”.

same happened in 2006-2007. The cover page of The Economist in 2006 called out real estate being in “the biggest bubble of all time”.

Bubbles don’t come out of nowhere. Everyone sees it coming. WHEN it bursts…that is what nobody sees coming…

 

A little off topic, but maybe helpful. If this kind of thing stresses you out, I have a few simple rules I have followed to eliminate any anxiety. With this, you can allocate huge amounts into investments very fast. 

-No meaningful personally guaranteed debt.

-Live far below your means. I have a mortgage but the place I bought is so cheap we could pay for it very comfortable off my fiance's income alone. For color, my cost of living is probably equivalent to what some of my entry level management people make. Any "excess" like my love of nice food is easily cut and not a fixed expense.

-If what you want was 5x the price, you can't afford it.

I know it seems risk-adverse and "simple", but by following those rules I've been able to feel great about putting on relatively high risk bets from early 20s until now (28). The other thing I find that makes taking big losses OK mentally, is ensuring every investment has a learning opportunity paired with it. If you're allocated into an emerging HF manager and you learn a lot from speaking with the founder or seeing how he runs his business...a loss or mediocre performance isn't as big a deal as if you had yolo'd on crypto or something.

 

+SB

I'm a few decades into my career, make $200k+ and I can keep myself clothed & fed on unemployment checks alone (SPOILER ALERT: Unemployment doesn't pay a whole lot!). I have some side interests that can keep income coming and keep me going indefinitely (although life would be a little less fun than it is now). I know people who make 3-4x what I do but can't get off that treadmill because they have a massive nut to meet every month. That's not going to be me, I made that decision a long time ago. I put away money every year and I also actively manage my own investments. That brings me more satisfaction and peace-of-mind than most anything dumb I can spend my money on. 

 

Read Ray Dalio's book on big debt crises. Any coming recession is unlikely to be a de-leveraging recession as defined in his book. This means that credit markets will likely remain fairly intact and the recession will be garden variety, rather than history making. It is unlikely that large banks will be in a position to be worried about their own liquidity and solvency. We will see tech take a hard hit, overall stock market correction, and perhaps moderate declines in home prices in certain areas. Households are under-leveraged by historical norms. 

 

Only over leveraged by certain metrics (perhaps the more important ones), so I won't disagree. However, if you go onto FRED and look at US corporate debt as a % of company net worth (market value) and % of GDP, you'll see they aren't over leveraged by historical norms. The debt to GDP metric is important to see how the debt would impact the overall economy in a recession. If you look at debt to EBITDA or other similar metrics, then we are at a concerning level of leverage. 

 

I lived both through 2001 and 2008. I'm not making any predictions but I will draw some of the parallels and things that concern me going forward. You'll note that I'm trying to look at both sides of things because I think its a different societal/government/global/whatever environment at the moment:

  • I read some commentary about how the used car market is leading to a period where people will be underwater on their cars for a very long time to come. If you've bought a car in the last two years, you overpaid big time. As soon as the supply catches up, that car loan goes negative. That has the potential to affect more people than the housing crisis albeit on a smaller amount
  • The biggest item that I think most people lack knowledge on (including myself) is the use of SPACs. I'm not sure how many people truly understand how popular those have become. Those have a huge probability of causing systemic failure in the markets. 
  • The government has never been as "friendly" as it is now to giving bailouts. If you look at the pandemic, there was a bailout for everything. Will that continue? Are we going to bail people out of car loans? Student loans? Bitcoin crashes? It feels like a bailout for anything is truly possible. Where will the government draw the line? 
  • BNPL plans - can't quite put my finger on the scope of the risk here, but its another item that is insanely popular. My gut tells me this will contribute to any coming collapse
 

- Car loans are very far from having a systemic impact like MBS had in 2008.

- Nearly all SPACs have already crashed and the number of incoming SPACs has been reduced drastically.

- Seems more like a political problem than anything. Inflation is obviously concerning, but I have an extremelly tough time seeing how 5-10% inflation for 2-4 years could cause a bubble.

- Completely agree on this. Risk assessment is very loose and and I could see a few of these companies getting wipped out completely. Still extremely unlikely to cause any systematic issue, because it's a minuscule part of the economy. Could be a big problem in the future if it grows without any more regulation tho.

 

Do you not see how prolonged inflation could lead to a recession? If most Americans are living paycheck to paycheck and wages can’t keep up, disposable income drops.

Demand for everything from houses to cars drops as consumer sentiment declines. Look at the UMich survey.

I’m pretty saddened that inflation is not mentioned more in this thread. Nobody should be buying the “supply chain issues cause inflation” narrative, but people continue to. Monetary and fiscal policy overshot demand and supply could not keep up.

 

Forward PE of SP500 is at 22 or close to. That's an earning yield of close to 5%. Even if interest rates rise we're very far from a generalized bubble.

Shitcos and companies without a path to profitability were obviously overvalued, but you can't generalize this to equities as a whole.

 
DeWitt23

Forward PE of SP500 is at 22 or close to. That's an earning yield of close to 5%. Even if interest rates rise we're very far from a generalized bubble.

Shitcos and companies without a path to profitability were obviously overvalued, but you can't generalize this to equities as a whole.

Forward P/Es assume that earnings actually happen as expected.    Maybe and maybe not. 

 

Interesting to note that the sole talk of Fed raising interest rates made cryptos crumble. 

For something that's promoted as alternative to the USD, world currency or whatever you want it to be, whose value should be dependent solely on supply and demand, it seems to be far more dependent on money printing than stocks

Never discuss with idiots, first they drag you at their level, then they beat you with experience.
 
Most Helpful

some thoughts here: https://www.wallstreetoasis.com/comment/2670962#comment-2670962

grantham is intelligent but rarely accurate. it's important to be aware of the risks, but often times grantham waves his hands and then comes back with the same answers of raising cash and buying value (fucking duh dude). a counterpoint from someone with a track record and as much/more experience than jeremy (howard marks of oaktree)

As mentioned earlier, investors often engage in selling because they believe a decline is imminent and they have the ability to avoid it. The truth, however, is that buying or holding – even at elevated prices – and experiencing a decline is in itself far from fatal. Usually, every market high is followed by a higher one and, after all, only the long-term return matters. Reducing market exposure through ill-conceived selling – and thus failing to participate fully in the markets’ positive long-term trend – is a cardinal sin in investing. That’s even more true of selling without reason things that have fallen, turning negative fluctuations into permanent losses and missing out on the miracle of long-term compounding.

When I meet people for the first time and they find out I’m in the investment business, they often ask (especially in Europe) “what do you trade?” That question makes me bristle. To me, “trading” means jumping in and out of individual assets and whole markets on the basis of guesswork as to what prices will do in the next hour, day, month or quarter. We don’t engage in such activity at Oaktree, and few people have demonstrated the ability to do it well.

Rather than traders, we consider ourselves investors. In my view, investing means committing capital to assets based on well-reasoned estimates of their potential and benefitting from the results over the long term. Oaktree does employ people called traders, but their job consists of implementing long term investment decisions made by portfolio managers based on assets’ fundamentals. No one at Oaktree believes they can make money or advance their career by selling now and buying back after an intervening decline, as opposed to holding for years and letting value lift prices if fundamental expectations prove out.

When Oaktree was formed in 1995, the five founders – who at that point had worked together for nine years on average – established an investment philosophy based on what we’d successfully done in that time. One of the six tenets expressed our view on trying to time markets when buying and selling:

Because we do not believe in the predictive ability required to correctly time markets, we keep portfolios fully invested whenever attractively priced assets can be bought. Concern about the market climate may cause us to tilt toward more defensive investments, increase selectivity or act more deliberately, but we never move to raise cash. Clients hire us to invest in specific market niches, and we must never fail to do our job. Holding investments that decline in price is unpleasant, but missing out on returns because we failed to buy what we were hired to buy is inexcusable.

We’ve never changed any of the six tenets of our investment philosophy – including this one – and we have no plans to do so

source: his latest memo https://www.oaktreecapital.com/docs/default-source/memos/selling-out.pd…

finally OP, since you're young it's really good you're asking these questions. when I was your age, I had to develop similar heuristics to cut through bullshit until it sunk in, I'll offer a few tips, may be worth its own post someday

  • what does this person stand to gain by saying this?
  • what do they stand to lose if they're wrong? HINT: if they lose nothing by being wrong on very strong views, tread VERY VERY VERY carefully
  • are they merely a strategist? or, do they actually have skin in the game by the way of client AUM and/or personal AUM following their views?
  • how are they invested personally?
  • is this what they always predict or have their predictions changed over time?
  • what is their track record of predictions?
  • what's their investment track record? is it so far superior to their competitors that they may actually have an edge?
  • in the face of them being wrong (because everyone eventually is), how have they reacted?
  • what happens if I follow their advice and they're only roughly right (e.g. speculative stocks correct but JNJ and CVS don't for example)?
  • what were they saying before, during, and after recent crises and run ups? were they always bearish? always bullish? 

I say the above because people like grantham at this point in their lives don't give a fuck if you make good returns, they've made their billions, aren't blowing the doors off anybody with their CAGR, and now feel entitled to take shots at the powers that be because they believe they know how to run the world better (maybe they do, impossible to know). and so while I read most of his stuff to get my bearish take, I often find myself asking at the end "so what?" and far too often, the "so what?" is the same shit he's been saying for 40 years - avoid high PE profitless bullshit, raise some cash because he's a chicken, and buy value (US, europe, japan, etc.).

 

Very well said. Read Grantham, Read Hussman do not ignore them think through their data and their theories. Read and see what Dalio says. All of these should invoke thoughts and reasoning but end of the day all these guys are better "teachers than actors" now. They all do their victory laps on twitter moment they are right. But Ray says "cash is trash" and every dollar you make put into the market asap no matter what, Jeremy would tell you hold a basket of value and buy puts, Hussman would tell you hide under your bed and buy expensive puts cause they will work someday. 

That all said they all have better access to data than the rest of us, they are able to talk to people with influence more than us just dont mean their conclusions are correct.  

 

Speaking of Oaktree and Howard Marks -- this directly contradicts your thesis here.

Check out this video from Feb 2020 (very end of pre-pandemic markets).  See how risky he thought the environment was pre-COVID. And I think everyone would agree the risks in markets are much higher now than they were then when Marks gave this talk (setting aside COVID, which was an exogenous event that wasn't contemplated in Marks' comments here)....

Watch starting at 1:10.  

 

I've read all of his memos, have not watched the speech, may do later. EDIT: just watched last 10 mins, doesn't change what I wrote below

how does it contradict my thesis? all I did was paste an excerpt of one of howard's memos. he's always talking about how there's risk out there, and I think this deserves some additional thought. staying fully invested does not mean being 100% invested in what's hot today, it means realizing that it's impossible to be a successful tactical trader over many market cycles, going all in, all out, raising cash aggressively just because you're scared, rather they feel it's their job to find value where they see fit, and commit client capital there, adjusting the level of risk they take within their investments due to the market opportunity, rather than wait for the golden opportunity to start investing, because there is never an all clear signal that things are going up from here.

I also think that there may not necessarily be more risk today as there was pre-covid, it just feels worse because everyone's talking about how risky things are because we have the virus, rate increases, inflation, etc. the good news is when markets are falling, those risks are being priced in. after 2019 which was a straight up year with no vol, very little risk was getting priced in, so a slight disagree with you there. that said, I don't think you're wrong in saying the market has risk today, I just think you need to go to the second level of that thought. we all know there's always risk, but it gets extra risky when it's not being priced in. while things could fall another 10-20% at the index level, I don't view that as risk, I view that as a healthy correction. in fact, I'd be more worried if the nasdaq did a total 180 and went up 30% while the fed was raising rates

make sense? I know that was rambly but you pose a good question, happy to clarify or continue back and forth if desired

 

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