We are in a bubble economy. There is little question about that. When the Fed nearly quintuples the adjusted monetary base from 2008 to 2014, there have to be major misallocations.
The problem is figuring out where the bubbles are and when they are going to pop. If you can figure this out, you can make a lot of money.
As I write this in late October 2019, I think the biggest bubble in the United States is in stocks. I am talking about the major categories: stocks, bonds, real estate, oil, and even gold.
Cryptocurrencies – the most famous of which is Bitcoin – are probably one gigantic bubble, but I don’t know this for certain. We hear that stocks can’t go to zero, or at least not when taken as a whole. I think it is possible for Bitcoin and other cryptocurrencies to go to zero or near zero. I am not saying this will happen, but only that it reasonably could.
The Bitcoin market is relatively small though. Most people don’t own any Bitcoin or any other cryptocurrency. Some may never have heard of Bitcoin. Many do not even know what it is. Therefore, I do not consider it an important bubble, because not that great of a percentage of people will be hurt by it if it goes bust.
For commonly owned assets/ investments, I think stocks are the biggest bubble. If you have a brokerage account or 401k plan, you should take this into consideration. It wouldn’t surprise me if stocks stay down for a while after the next crash. It may not be like the last decade after the 2008 financial crisis. Even if the Fed does create new money like crazy, it may not have the same stimulative effect on stocks the next time.
Bonds may be in a longer-term bubble. Corporate bonds will likely take a hit in the next recession, but I am talking about U.S. government bonds. Some day, interest rates are going to spike much higher, crashing the long bond bubble. However, in the near term, bonds will likely do well. As long as price inflation expectations remain relatively low, people are going to seek safety in bonds in the next economic downturn. Long-term interest rates could go even lower from where they are now.
I believe real estate will go down in most areas in the next recession. I doubt it will be as bad as the crash in the mid to late 2000s decade. It’s possible, but not likely. Prices in many places are still below the peak in housing prices from around 2006, despite the inflation since that time.
Therefore, I think if you are looking to buy a house – whether it is to live in or as an investment property – you will probably get a better deal if you wait for the next recession. But I also don’t think it will be as much of a catastrophe for as many people as what we saw around 2007 to 2009.
Regarding oil and gold, I would not put these in a bubble category right now. Both could certainly go down in price with a recession, but it likely will be minor compared to other asset classes.
Driving Luxury
Now I would like to discuss automobiles. I believe this is a major bubble, but I am not clear on how it will play out. Buying a car is not as big of a purchase as buying a house. It is easier to get rid of a car than to move out of a house. It is also less of a problem for the lending institutions when it comes to defaults, but it is still a problem.
The average new automobile sells for over $36,000 now. This is over half of the median annual family income (before taxes).
My son likes to look at nice cars. Sometimes, when I am driving him somewhere, we play a game where we call out if we see a nice car. I know the term “nice” is subjective. We generally count any of the luxury cars. We count any Tesla, Mercedes, or Audi. We will usually count Lexus, Infiniti, Mustangs, and Corvettes, although I know that some of these cars can be bought new for under $40,000.
On a 25-minute drive, it is not uncommon for him to find 50 cars. I am lucky to find 10. I have to concentrate on driving, and his eyes are better than mine. Plus, he knows his cars well and can pick them out from far away.
One of the areas during our typical drive is in an upscale neighborhood. The people living there really are in the top 1%. Therefore, my story is a bit biased, as part of the drive is in an area where people have significant wealth, or at least significant income.
Still, on a 25-minute drive, to see about 60 cars, most of which are bought for over $40,000, is quite astounding. I’m sure there are some Acuras, and even the occasional Hyundai, which retail for more than $40,000 new, but we don’t count these.
There are a lot of people driving really nice cars. I can appreciate a really nice car, but I can’t justify spending the money on one. My wife drives a minivan that we bought slightly used. That is as luxury as I will get.
In some ways, the luxury cars on the road are a symbol of our wealth. In other ways, it is a symbol of a bubble that is about to pop. I wonder what percentage of these people can actually afford these cars. Sure, they can afford to make the payments on them, but I’m guessing many of them would not be able to pay for them in cash. And many more won’t be able to make the payments when the next economic crisis hits.
In the really nice neighborhood we drive through, I am guessing most of these people will be fine in an economic downturn. In terms of raw numbers, and maybe even percentages, they will take the biggest hit in terms of net worth. The upper class owns the greatest percentage of stocks, so they will take the greatest hit. But if your net worth goes from $10 million to $5 million, you are still doing well compared to most others.
I believe we do have an automobile bubble. Like other bubbles, it has been fueled by easy money and artificially low interest rates. When people can make payments for 6 or 7 years, it makes the asset look affordable. Maybe it is affordable, but that doesn’t make it wise.
There will be a lot of defaults on car loans when the next recession hits. The rise in defaults may start before the recession is evident. This will hurt banks.
It is easier for people to turn in the keys to their car than it is to turn in the keys to their house. It isn’t much of an adjustment to drive a car that is less luxurious. The biggest adjustment is the hit to someone’s ego.
Although we can thank government for the high prices of new vehicles, I believe prices will come down in the next recession. If you are looking to buy a new car, it is best to wait at this point if at all possible. When people start getting tight with their money again, they will not be buying new cars. Dealerships will get more desperate to sell new vehicles. There will be better deals available.
Every bursting bubble has advantages for someone. It is usually people will cash waiting to buy.