This article identifies at least three bubbles in today’s markets. The major bubble is in technology stocks. It also lists several strategies on how to deal with the bubbles, but points out that bubbles can continue for a long time before they pop.
Our view is that the market constantly creates single-asset micro-bubbles, isolated examples of extreme mispricing which require severe right-tail outcomes to justify the asset’s price. Over the first quarter of 2018, Tesla has been an excellent example of a micro-bubble. Tesla’s current price is arguably fair if most cars are powered by electricity in 10 years, if most of these cars are made by Tesla, if Tesla can make those cars with sufficient margin and quality control and can service the cars properly, and if Tesla can raise additional capital sufficient to cover a $3 billion annual cash drain and another billion to service its debt. To us, that seems an unduly optimistic array of assumptions, especially given the magnitude of Tesla’s debt burden. Such an argument ignores the deep pockets of competitors and the common phenomenon of disruptors being themselves disrupted by newcomers. Absent the unfolding of this rosy scenario, Tesla’s current price would require remarkably aggressive assumptions to deliver a positive risk premium. For investors who agree with this assessment, Tesla constitutes a single-stock micro-bubble.3 This example also illustrates a key point about bubbles: Because the current price is acceptable to the marginal buyer and seller, there will always be a cohort that says, “This is no bubble!”
Sector and broad market bubbles are much rarer events. In this context, a bubble occurs in a sector or a market for which an implausible set of circumstances must prevail in order for the sector or market to collectively deliver a positive risk premium relative to bonds or cash, even though sufficiently aggressive assumptions could realistically occur to justify any single stock’s price.