Beating the benchmark – Is the superbubble bursting in 2023?

THIS year started with a rip-roaring rally in the markets. Both US and emerging markets equities bounced over 20 per cent on average; some of the major growth stocks surged by 100 per cent compared to 2022. Bond market yields have fallen dramatically, soothed by the perceived “balm” of falling core inflation.

In recent weeks, we have also witnessed the collapse of tech lenders Silicon Valley Bank, Silvergate Bank and Signature Bank, as well as UBS Group’s state-backed takeover of banking giant Credit Suisse – events that challenge confidence in the banking system.

The earlier calm we experienced has now given way to tumult. The proverb “still waters run deep”, while just cautionary, is a reminder to look even deeper beneath the surface, where there is much turbulence.

Formation of a superbubble

Bubbles are speculative events where there is a rapid escalation in the price of assets, often in reaction to some “technological innovation” that attracts and is supported by vast amounts of financial capital to the point where collective euphoria suspends disbelief and market values defy sustainability.

It is at the peak of this euphoria that the bubble unfailingly bursts. A financial crash ensues, accompanied by a significant economic slowdown, wiping out the hopes and dreams of investors. The larger the breadth and magnitude of the bubble, the greater likelihood of a deeper entrenchment and decades-long economic malaise.

The 2022 superbubble

In the past 50 years, we have experienced a series of bubbles, some your garden variety 2-sigma event types, others your 3.5 sigma variety or “superbubble”. More concerningly, their frequency and size grew.

Last year, we witnessed the culmination of an “asset superbubble”, and coined the “everything bubble”. What made this superbubble so remarkable was that it was global and multi-asset-based, with valuations exceeding all historical precedents in excess.

We experienced bubbles in housing, bonds, stocks, commodities, art, wine, vintage cars, and sports cards – if you can name a tradeable asset, it’s likely been in a bubble!

This superbubble was formed because of the monetary easing from the US Federal Reserve that impacted most asset classes across equities, bonds, housing, commodities, cryptocurrencies and even Special Purpose Acquisition Companies (SPACs). This year, in just a matter of weeks, we have seen how the market scripts have flipped.

The Covid-19 pandemic and the Russian invasion of Ukraine led to a significant rise in inflation at the same time as a global slowdown was underway, spelling stagflation.

We are now reeling from the impacts of the pin, pulled from a Russian hand grenade in February 2022, having pricked the superbubble. The Russo-Ukraine war exacerbated already fragile supply chains and access to raw materials, which resulted in the Fed kicking off widespread central bank monetary tightening to combat the inflation spectre.

This sequence of shocks to the global economy led to a notable and rapid strengthening of the US dollar against most currencies.

With the superbubble experiencing signs of deflating, a recession is now looming over the next 12 to 18 months of a magnitude greater than what we have seen since 2008.

However, will this lead to a major crisis like 2008? Responses from other central banks in managing interest rates via yield curve control – a monetary policy action where central banks purchase variable financial assets to target interest rates at a certain level – will determine if global financial conditions tighten rapidly and uncontrollably, causing assets to plummet in value.

While there is an abundance of commodities in the world to meet our demand, the crux lies in accessibility. Deglobalisation, protectionism and polarised politics create friction in supply and volatility in its ebbs and flows.

With the growing trend of deglobalisation, many touted threats from foreign digital currencies (central bank digital currencies) could rapidly depreciate the USD as it loses its reserve status, especially if the US government loses control of its fiscal situation. This is not my base case. Tales of the greenback’s demise, in my view, are far from imminent and not in the best interests of both the West and East, at least for now.

Technology singularity – the next wave

With the proliferation of cloud and artificial intelligence, the cost to compute is racing down to zero. This provides a disinflationary effect which can offset the inflationary effects of raw material constraints and fiscal incontinence, as long as there is access to the rare elements needed for computer components.

With “technological singularity”, at a hypothetical future point in time when technological growth becomes uncontrollable and irreversible resulting in unforeseeable changes to progress in human civilisation, certain equities can soar in value.

If fusion energy is harnessed in the next two decades, it would propel equity markets exponentially higher. It’s far too premature for markets to discount this.

Little, often and early

The path ahead may not be rosy, but prices and yields are offering far more value than a year ago and I believe we will get even better valuations to invest.

My approach to investing is to average-cost across a portfolio of asset classes. When valuations are historically extreme, I reduce my monthly investment and increase it again when valuations are fair, and even more when they fall well below trend growth.

Start saving today; it’s never too late or too early. Budget accordingly, save regularly, and prioritise it before all other expenditure, if possible. Select investments prudently to safeguard your savings from the eroding effects of inflation. This is how we beat the benchmark.

Ben Davies is co-founder and chief operating officer of Hugosave. He is an investment veteran with over 25 years of investment management and principal trading experience.