Are we in another financial bubble? It feels like it given how aggressive the Fed has hiked rates. It's best to prepare for another recession just in case. One of the biggest reasons why I believe we could be in another financial bubble is the incessant amount of stock tips I'm getting from people with no experience. For example, my preschool teacher friend won't shut up about Tesla. Another another guy in marketing won't stop talking about Bitcoin.
Online investing advice by non-finance professionals is the modern day version of shoe shine boys giving stock tips prior to the crash of 1929. Always understand the background of those who give investment advice before considering their counsel.
A Financial Bubble In The Making
Even after 28 years of investing and working in the finance industry, I still feel uncomfortable giving any sort of investment advice. There is no certainty when it comes to investing.
I've had way too many losses partly thanks to multiple boom and bust cycles. Furthermore, everybody's risk tolerance and money making abilities are different. The best thing we can do is have an appropriate asset allocation to ride out the waves.
The good thing about a financial bubble is that the greater fool game can last for much longer than expected because we humans are GREEDY, GREEDY, GREEDY!
The largest criers of the word “BUBBLE!” are those who have the least amount at stake. Perhaps they sold their real estate, stocks, or businesses before 2012 or during the March 2020 sell-off and are now kicking themselves.
Maybe they are still graduate students with a lot of student loans to repay. Or maybe they are retirees or early retirees who can no longer take full advantage of a heated economy. Whatever the case may be, when the largest complainers of a financial bubble start getting back in, you know danger is imminent.
Let's at least all agree that we're in the second half of a bull market and the financial bubble will eventually burst. In fact, that's exactly what happened in March 2020, about two years after I originally published this post. It is a certainty we will go through another 20% correction again.
When Will The Financial Bubble Burst?
I predict the bubble will burst on July 1, 2024. Heck if I know! Your guess is as good as mine. When the bubble bursts, there will be plenty of private companies at crazy valuations going bust because they still won't be profitable and nobody will give them any more money.
We have pre-product, pre-revenue startups being valued for $8 – $12 million dollars all the time nowadays. Furthermore, plenty of private companies are trading at 15-25X revenue with the expectations of never ending triple digit growth.
The private equity market is completely out of control compared to the public equity market. It's been eye-opening these past two years consulting in startup land. Once the private equity market collapses, it will pull down every other asset class with it. At least the Fed will think about cutting rates again.
If we can hold on through the downturn, and continue to dollar cost average, we should be fine in the long run, especially since most of us don't have access to such private equity companies.
The goals for all of us are to:
1) Recognize when we are in a bubble.
2) Maximize our returns during a bubble.
3) Slowly minimize risk and exposure the larger the bubble grows.
4) Try to exit as much as possible before pandemonium sets in.
5) Have enough cash once the bubble bursts to buy everything in sight.
Remember, you must convert some of the funny money into real assets or fantastic experiences. Otherwise, when the bubble bursts, you might be left with NOTHING but regret!
CHARTS SHOWING BUBBLISCIOUS VALUATIONS
Whoah! San Francisco median home prices have skyrocketed by 100% since 2012. The median household income in San Francisco is about $80,000 while the median home price is now $1.7 million. In other words, the median house costs 21X the median income when banks only lend at most 5X one's gross income (used to be 3X, but rates have come down to more affordable levels).
But who cares about the banks? They don't lend to good creditors anyway! More people are buying with cash, and more people are coming from “low per capita GDP” nations like China with bucket loads of dough. The San Francisco housing market is a bubble for local residents. Good thing San Francisco faces a strong international demand curve. But when the US bubble bursts, foreign money will disappear.
A financial bubble tends to occur. when home prices rise faster than rents. See examples below.
The real estate charts for Los Angeles, San Diego, Manhattan, DC, New York, Paris, Hong Kong, London, Singapore, Miami, Sydney, and so forth all have similar trajectories. The median home price to median income multiples are also at nose bleed levels.
STOCK MARKET BUBBLE?
Excluding the maginficent 7 tech stocks (mega-cap tech stocks), the S&P 500 is fairly valued as of 4Q2023. But the thing is, you can't invest in the S&P 500 easily without the highly valued mega-cap tech names.
Everybody has heard of the 7-year economic cycle right? If you haven't, it's a theory that basically says things go up for five years, down for two years, up for five years, and then down for two years over and over again. Some interpret the cycle as a 7-year bull run followed by a downturn.
We'll have higher lows and higher highs over the long run. But over the short run, we could be in a world of hurt. Here's my current portfolio of stock picks.
Maybe We're Not In A Financial Bubble
There is no way any of us will be completely unscathed from a bubble collapse because none of us will be able to perfectly time our exit to 100% cash.
Let's look at another interesting chart to compare today with the internet bubble of 2000. I remember almost investing $20,000 into my college alum's now defunct company called DormNow. Those were the glory days when Yahoo stock would jump 10% a day!
Thank goodness we're no longer valuing companies based on “eyeballs.” I still remember my company's old Internet Analyst, Anthony Noto (now CFO at Twitter), producing an Internet report with googly eyes on the cover. Then there was Henry Blodget who was pumping Amazon to $400. It was nutso and people made a boatload of money! Even I got lucky and made a 40 bagger with one ridiculous company named VCSY that went bust shortly after.
The chart above shows how reasonably valued some of the largest NASDAQ companies are today vs NASDAQ companies in 2000. Apple trading at 15X earning with $150+ billion in cash doesn't sound like a company that's ever going bust. In fact, the likes of Apple and Berkshire Hathaway could be our saviors if there's another correction.
The issue I see is mutual funds, who have expertise in public market investing, seeking 10% returns by participating in late stage private financing for bigger gains. They are investing in what they don't know and being too cavalier with their assets.
The Financial Bubble Will Eventually Bust
When the bubble bursts, I pray everyone has a diversified net worth to hold them through for at least two years. And if you end up losing your shirt, don't worry. The bubble was fun while it lasted! There will always be another bubble to profit from. It's the American way.
Here's what I'm doing to help buffer myself from a financial bubble collapse:
- Raised my after-tax savings rate to 70% from 50% now that my master bathroom project is done (post coming) in order to increase liquidity and build a war chest in case opportunities arise.
- Looking for new online business partnerships so that no one revenue stream takes up more than 30% of total revenue. Client concentration risk is the downfall of many companies.
- Write more bearish articles like How To Make A Lot Of Money In A Downturn, that help people during downturns in order to diversify traffic on Financial Samurai in case a downturn happens. Part of being a good publisher is properly forecasting the future of what people might be talking about.
- Completely pay off a rental income property mortgage that will free up $1,308 in monthly cash flow, and increase my cash flow by ~$2,000 in the eyes of a mortgage underwriter due to their funny math of discounting rental income by 25% if one has a mortgage. I'm essentially preparing myself for one last attempt at refinancing a primary mortgage just in case interest rates start collapsing again.
- Continue to buy equity via structured notes with 20-30% downside barriers or buffers as part of my monthly investing contribution as opposed to buying naked equity.
- Constantly review my net worth allocation online to make sure my stock market exposure as a percent of my overall net worth is no more than 30%.
- Diversify into real estate through real estate crowdfunding and rental properties. Real estate is a laggard asset class and is more stable. Given real estate produces income, the value of cash flow and real estate has gone way up because interest rates have come way down.
- Holding cash and Treasury bonds given they are yielding 5%+.
Below are some more detailed recommendations on what to do during a financial bubble.
Invest In Private Growth Companies
Consider diversifying into private growth companies through an open venture capital fund. Companies are staying private for longer, as a result, more gains are accruing to private company investors. Finding the next Google or Apple before going public can be a life-changing investment.
Check out the Innovation Fund, which invests in the following five sectors:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- Development Operations (DevOps)
- Financial Technology (FinTech)
- Real Estate & Property Technology (PropTech)
Roughly 35% of the Innovation Fund is invested in artificial intelligence, which I'm extremely bullish about. In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI!
The investment minimum is also only $10. Most venture capital funds have a $250,000+ minimum. In addition, you can see what the Innovation Fund is holding before deciding to invest and how much. Traditional venture capital funds require capital commitment first and then hope the general partners will find great investments.
Diversify Into Real Estate
Real estate is my favorite way to achieving financial freedom because it is a tangible asset that is less volatile, provides utility, and generates income. Stocks are fine, but stock yields are low and stocks are much more volatile. The -32% decline in March 2020 was the latest example. However, real estate held steady and appreciated in value then.
At this point, I think it's better to invest in a laggard asset than in an expensive stock or stock market that is priced to perfection.
Take a look at my two favorite real estate crowdfunding platforms that are free to sign up and explore:
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends.
I've personally invested $954,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. Real estate crowdfunding comprises of about $100,000 out of my $350,000 in passive income. Always be building passive income for financial freedom!