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All bubbles are not equal

Predicting the growth and bursting of bubbles is a difficult task, even considered as impossible by some. In fact, bubbles can last for a long time and are only apparent when they burst. Calling them too early can lead to suboptimal allocation.
Didier Borowski, Head of Global Views; Pierre Blanchet, Head of Investment Intelligence
Amundi Asset Management,  March 03, 2021


Predicting the growth and bursting of bubbles is a difficult task, even considered as impossible by some. In fact, bubbles can last for a long time and are only apparent when they burst. Calling them too early can lead to suboptimal allocation. However, there are signs of market exuberance, particularly in the tech sector. These high valuations are driven by high growth expectations and, more importantly, ultra-low discount rates, the normalisation of which could trigger a bursting of the bubble. Although a major source of risk for investors, history shows that all bubbles are not equal when it comes to their impact on the economy.


Cycles in financial market segments (equity, housing or credit) are playing an important role in shaping recessions and recoveries. The current recovery has hardly started, and growth might surprise on the upside in the short term. In the US, President Biden’s $1.9 trillion (9% of GDP) fiscal stimulus plan raises concerns of overheating in the second half of 2021. Chinese GDP might grow as much as 9% this year. Europe, for its part, is expected to benefit from two consecutive years of strong growth. Inflation is expected to rise too, in particular in the US. Although it would be short-lived in our view, an inflationary miniboom would also boost corporate earnings expectations and investor confidence. The strong momentum on the equity markets might therefore continue for some time, supported by strong nominal growth.

The most striking feature of this new cycle is the level of indebtedness. Private and public debt post- Covid-19 have surpassed the historical highs reached at the end of WWII. Higher nominal GDP growth might support debtors but at the same time should lead to higher long-term interest rates. It might also put central banks, and the Federal Reserve in particular, under pressure to withdraw their accommodative programmes. However, as we argued in last month’s paper (Taper or not taper), the Fed is unlikely to stabilise its balance sheet and raise policy rates until the economy is well on track: returning to full employment will take much longer than returning to pre-crisis GDP levels. The slack in the job market should prevent wages from soaring (the Phillips curve has flattened) and, in any case, the Fed has adopted for a new strategy (average inflation targeting) that allows it to wait and see if inflation surprises on the upside.

Finally, maintaining bond yields well below nominal potential GDP growth is a prerequisite for public debt sustainability.
Therefore, a potential outcome of this unusual recovery, in which CB balance  sheets will continue to grow even as growth accelerates, is an asset price bubble, starting with assets whose valuations are highly sensitive to distant future profits.

Signs of bubbles

Tech stock valuations have skyrocketed since the middle of last year, and investor behaviour looks increasingly inconsistent with reasonable investment approaches, unless the framework described above lasts for a long time. Signs of a bubble can be seen in many aspects of the equity market. Retail investors’ actively trading in upside options, the ever-growing market caps of a limited number of stocks, and IPO flows are among the numerous signs of a bubbling digital sector. Inflated valuations cause optimistic analysts to change their valuation methods1. The fundamental background is nevertheless real, as we are witnessing another phase of the digital revolution, exacerbated by restrictions on mobility and human interaction. But the ultra-low interest rate environment clearly brings valuations back to levels not seen since the tech bubble of the 00s.

The spark is nearly impossible to predict

Financial market bubbles are difficult to predict and are ex-post concepts. This one might last a few more years, and history shows that market exuberance can persist over a long period. Alan Greenspan’s famous speech was made in 1996 and the dotcom bubble had another four years before bursting. In a context characterised by excess savings over investments, interest rates can remain very low for several years, while the digital transition is accelerating. Looking forward, high indebtedness may weigh on domestic demand, the inflation mini-boom might only last for a couple of quarters, while fiscal boosters might also prove short-lived. These would support asset price bubbles in sectors with sustainable growth, such as the green and digital sectors. As these conditions may last for a long time, it is not easy to predict the spark that would lead to the explosion, and thus it would probably be suboptimal to reduce exposures too early that said, the recent rise in real rates should be monitored very closely.

All bubbles do not impact the economy in the same way

We might not be able to tell at which stage of the bubble we are2, let alone when it might burst. But we can still make assumptions about its consequences for the financial markets and the economy.

History shows that bubbles can have a different impact on the economy once they burst, regardless of the magnitude of the initial financial shock. Indeed, the Japanese real estate bubble of the 90s, the Asian credit bubble of 97 and the subprime bubble of 08 have been far more impactful than the 00s dotcom bubble or the Chinese 2015 equity market boom and burst.

Although every situation is different and it is not possible to have clear-cut categories, bubbles can be grouped into two clusters: equitydriven bubbles and credit-driven bubbles.

  • Equity bubbles are based on excess inflows into equities or their equivalent. They mainly have an impact on wealthy households and fast-growing corporates, but little impact on the vast majority of households3 and non-bubble prone sectors. Moreover, are excess savings driven by over-optimism and overinvestment in innovation despite unproved profitability. Therefore, when a bubble bursts, it is a lost opportunity in the future more than anything else.
  • Credit bubbles are also driven by excess liquidity but the bubble driver is excess leverage on tangible assets. They involve excessive optimism and over investment in the value of real assets which have an economic utility and usage. These bubbles tend to spread across a wide range of economic agents, including lowincome households. When they burst, they generate a loss of economic value today. By definition, these bubbles have a funding element which spreads to the banking sector.

The very short-term implications of both bubble groups are somewhat similar (equity market crash and panic selling, bankruptcies and economic recession), but the economic impact is ultimately very different. An equity bubble will mainly shrink the excess savings of already wealthy individuals and stay in the financial sphere with little impact on the real economy, whereas a credit bubble will hurt the middle class. Moreover, capital can be rebalanced towards other sectors or themes or simply saved for a while after an equity crash. The impact on growth is temporary. The 2000 dotcom and Chinese 2015 bubbles were followed by several years of strong economic growth despite significant portfolio losses4, not to mention the fact that certain segments of the equity markets proved resilient to the crash. Conversely, a creditdriven speculation with excess leverage leads to negative equity, debt deflation and, therefore, the withdrawal of available capital from the economy,which has a deep and long-lasting impact on potential growth.

Central banks will try to contain the crash

The current situation could be a mix of both equity and credit and the implications might not be as simple as we have just described. However, there are signs that this is probably an equity-type bubble, at least for now. The policy response can also tweak the process itself. An equity bubble bursting which stays in the financial sphere with limited consequences for the banking system, for instance, should not theoretically trigger emergency intervention from central banks. In fact, it could be seen as the collateral damage of a prolonged accommodative monetary policy. However, if this shock had broader consequences for the economy, affecting households, corporates, then banks and eventually states, the central banks would try to contain it. Indebted states would not use taxpayers’ money to protect speculators. But if it were to become a systemic risk, they would not have a choice. Rising credit spreads coupled with falling equity markets could then trigger a “balance-sheet recession”.

Therefore, we can infer that policy makers will watch carefully the boom and burst of what looks like an equity bubble and pre-emptively act to avoid it becoming an unmanageable situation. The investment implication is a gradual rebalancing away from the highly-valued tech sector into other segments in the current phase and a contrarian positioning during the fireworks.



1 “Irrational exuberance is the psychological basis of a speculative bubble. I define a speculative bubble as a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increases, and bringing in a larger and larger class of investors who, despite doubts about the real value of an investment, are drawn to it partly by envy of others' successes and partly through a gamblers' excitement.” Shiller, Robert J. March 2000 Irrational Exuberance, Princeton University Press.
2 See the five stages of the financial asset bubble by Hyman P. Minsky Stabilizing an Unstable Economy (1986).
3 While a majority of Americans have some level of investment in the stock market through retirement accounts, it is estimated that 84% of all stocks owned by Americans belong to the wealthiest 10%. See Household wealth trends in the US, 1962 to 2016: has middle class wealth recovered? E. Wolff, NBERWP (2017).
4 Note however that US real GDP did not post a single year-on-year decline after the bursting of the dot com bubble! (on a quarterly basis, real GDP just declined slightly in Q1 and Q3 2001).