How The Everything Bubble Will Burst...And How To Profit From It

9 בספט׳ 2021

I also created a video about my post for those that prefer to watch it here it is:
youtube.com/watch?v=_BfdyUm4I_o
It also contains all the graphs and charts which unfortunately I can not post here.



More and more market participants are talking about rising inflation and the everything bubble being the buildup to an epic crash. But is this really true? Can markets go anywhere but up?
So far since the beginning of 2020
Oil is up 103%
Gas 94 %
copper which is key in all our electronics is up 126%
iron the most used metal is up 150%
coffee is up 101%
corn is up 78%
wheat 49%
and sugar 87%



The housing market is up, the collectible market is up and the stock market does not look any different.
The S&P 500 has recovered above pre covid levels and gained 100 % from the bottom all the while setting 43 all time highs year to date literally a new all time high every 3.5 days in 2021 and on track to beat the record of 77 yearly all time highs in 1995.





Running hot? Maybe a little... Or maybe the economy is just growing at a really fast pace? Looking at the ratio of market value to GDP however the markets are extended over a large margin to where they should be in relation to GDP.


So whats going on here? Are we really in an everything bubble that is going to pop and if so how can you invest so that you make money? Before we can answer these questions we need to understand what a bubble is.
Whats a bubble
A bubble is defined as an economic cycle characterised by a rapid increase in market value particularly of asset prices. It is commonly accepted that bubbles arise due to the psychology of investors. They can appear across single assets, asset classes or entire markets.



Bubble Cycles
Bubbles always follow more or less the same pattern as we will see when we look at some bubbles that have occurred throughout history. At first things start slow as the smart money and early adopters get in on the trade.
More and more professional investors start to pile in as the price starts to increase leading to awareness of the opportunity to rise until it breaks into the public.
As more and more people learn about the trade and jump in because of greed and fear of missing out price starts to really take off and run away from fundamental valuations. It is this stage where mass psychology gets more and more amplified feeding into itself leading to enthusiasm turning into greed and delusion as prices reach higher and higher.
The stock market is a zero-sum game the profits of one market participants are anothers losses. The more retail is buying the more profits the smart money are taking.
This then is one of the most telling signs of a bubble: retail investors coming in and pushing prices ever higher left to hold the bag when the smart money ultimately leads the market lower in taking all their profits.
Famed investor Jim Chanos is warning about exactly this and just said in an interview with CNBC “The problem with getting more people, retail, involved is that it always seems to happen toward the end of every cycle. Retail wasn’t there at ’09 at the bottom. They weren’t there in ’02 after the dot-com bubble collapsed. They were certainly there at ’99,”- (Buying at the top that is) He goes on to say:
“(So) the problem in the last few cycles as I see it is that we get promotors and insiders and people who have done very well cashing out as retail is buying.”
Past bubbles and crashes

Lets take a look at some of these past bubbles to see how they stack up to where we are today.



What is widely considered to be the mother of all bubbles became known in history as tulip mania. It is one of the prime examples showcasing how irrational behaviour leads to asset prices rising to unsustainable levels before they finally collapse.
In 1630 tulips which had only been introduced to Europe in the 1600's were starting to be perceived as special and rare. This prompted speculation in the tulip market shortly after leading prices to increase by 2000 % between November 1636 and February 1637 before plummeting by 99 % in May 1637. During this period of time some tulips were costing as much as a house clearly showcasing the disconnect from fundamental values and the greed and mania involved which are key characteristics of bubbles. One can't help but see the parallels in looking at prices that some digital or physical collectibles are commanding these days.
Cryptopunk and Axie Infinity are just two examples of NFT's that can cost much more than even the most lavish of mansions. The most expensive crypto punk so far has been sold for 8 million dollars. The most expensive NFT so far Beeple’s, Everydays ” The First 5000 Days” sold for a staggering 69 million dollars. But also many physical collectibles are commanding hefty premiums with the most expensive Pokemon card having been sold for 369.000 dollars. Almost a bargain in comparison to some NFT'S.
Well to be fair though at least when the price of NFT's approaches its fair value somewhere closer to zero you will always still be the proud owner of your virtual good whereas the tulip will not only have lost its value but have withered away completely.
Japan
In our modern time many speculative bubbles have been attributed to overly lax and stimulative financial policies of central banks. Japan's economic bubble of the 1980's is a prime example for this. After Japan entered a recession in 1986 the government countered with huge monetary and fiscal stimulus. The resulting free and abundend liquidity led to rampant speculation in the japanese stock and real estate market with prices increasing by 300 % between 1985 and 1989 and retail going all in. The bubble burst when the fiscal stimulus was withdrawn in 1991 ushering in what is now known as the lost decade due to slow economic growth and deflation. Today 30 years later the Japanese market is still trading below its 1991 highs.
Dot com bubble


In the 90s the internet was a rising star and with it many companies trying to commercialise its tremendous potential. Venture capitalists caught on early and in easy monetary conditions were throwing money at dot com startups. The public started catching on in 1995 and retail trading became more and more popular. Everybody was sure that there was nowhere but up for internet stocks no matter what they did or whether they even had revenues. In 1997 record amounts of capital flowed into the NASDAQ. New online brokers were making it more accessible for the average Joe to buy and sell shares and everybody was buying into the trade of a life time. At the height of the bubble their advertisements were showing that trading is an easy way to riches. Between 1995 and 2000 the NASDAQ rose by 500% from below 1000 to over 5000 points. When nobody was left to buy the bubble finally burst and the NASDAQ lost nearly 80%. At this point even blue-chip tech stocks like Intel were down by 80%. What followed was an extended bear market and a slow recovery. It should take until 2015 for markets to recover to previous levels.
The dot com bubble actually spawned another bubble on its own as investors fleeing stocks piled into the real estate market. This became known as the US housing bubble which in the mid 2000s collapsed leading to a worldwide economic crisis today known as the great recession.
To support the world economy during this time the central banks of the world started implementing quantitive easing basically increasing the money supply by lowering interest rates and purchasing assets in order to help the economy recover. At this point unprecedented amounts of money were newly created and injected into the economy. Shockingly this actually continued until 2018 when the US Fed started to taper its asset purchases which caused a liquidity crisis in the markets that after 10 years of a non stop FED powered rally were not prepared to come back to reality.
As we have seen these bubbles develop and burst over and over again following the same pattern. The reason for this is that financial markets like the whole bubble dynamic are entirely driven by human psychology which is best illustrated in the different phases of bubble or market cycles.
Where are we in the cycle
Fast forward to today.
We have been in a central bank induced bull market since we came out of the last recession in 2008. In 2020 COVID hit and as result the markets collapsed and millions of people lost their jobs as the world battled lockdowns that led to stores and factories closing.
The worlds central banks jumped in swiftly - injecting more liquidity into the system than ever before. They cut interest rates to zero and started large asset purchase programs in addition to the government relief programs handing out money to everybody.



Just between March and June 2020 the money supply in the US increased by 300 % the largest spike ever. 40 % of all dollars in existence were printed within the last 12 months.
This flood of new free money quickly found its way into the stock markets since due to low interest rates lower risk assets are not yielding returns. Leaving investors no alternatives but to rotate to riskier higher yielding assets which today is known as TINA: there is no alternative.
As we have seen earlier this flood of money combined with supply chain shortages caused by Covid lead to rampant price inflation throughout different asset classes within a short amount of time. It sure looks like we are in bubble territory but where are we within the cycle?
One key characteristic of any bubble nearing its peak is the involvement of the general public or retail crowd. Therefor the degree to which retail investors play a part in the current boom cycle plays a key role in understanding where we are in the bubble. So what does the data tell us
Retail participation in bubbles



Since the beginning of the pandemic the amount of retail brokerage accounts opened has skyrocketed. Rxxbin Hxxd now has 18 million users almost doubling their amount of users before the pandemic started. They introduced fractional shares allowing you to start investing with as little as 1 dollar. Their advertising message is everybody is an investor and I guess in a bubble everybody is. The interest for trading has spiked online and offline. You know its getting sketchy when your little niece asks you for stock tips.





But there is not only more retail trading the new traders are also younger and more inexperienced. A large part of todays market participants has never even seen a market correction of more than 10 % let alone a true recession. It is no surprise than that these investors are overly optimistic and can not believe the market can go anywhere but up.
(It sure seems though that history is set to repeat and most of the retail crowd will be left holding the bag instead of taking home the tendies. As an old saying on wallstreet goes:
“A man with money meets a man with experience. The man with the experience leaves with the money, while the man with money leaves with experience.”)
The only thing more telling than the growing number of retail traders is the amount of money that has been flowing into the market.



Over the last 25 years global equities had inflows of 727 billion USD cumulatively. Now hold on tight because this is truly crazy. Global equity inflows for 2021 annualized amount to 1.015 trillion USD. Yes thats right trillion not billion almost 300 billion more than have been flowing into the market over the last 25 years combined coming in in just one year. Over 80 % of these flows have gone into passive funds, ALL US, ALL LARGE CAP. At the same time margin debt has risen to historic highs as well. Market participants have never been this leveraged before.
These days in the light of the FED support there is only one mantra driving the crowd: buy the tulip uhhh... dip.
Crash scenario
It seems then that retail is indeed all in or at least getting pretty close. Looking at these unprecedented huge inflows into equities and the retail trading frenzy it sure looks like we are in the last cycle of the bubble but how and when is it going to pop?
There are currently many challenges ahead that might trigger a bigger correction or crash leading to these bubbles to burst. Lower vaccine efficacy and the spread of the delta variant are impacting supply chains putting more pressure on already elevated prices and slowing down the Chinese economy. The FED starting to taper into a slowing recovery might as well be a recipe for the crash that we have been waiting for.
But whatever event is going to trigger the sell off every day margin debt is growing the resulting margin call avalanche that will ensue is getting bigger and bigger making sure that whatever correction we will see will not be a small one and might even trigger a recession.
How to profit from this
It sure seems like the central banks are running out of options and it will be very interesting to see how they respond to this.
So when is this going to pop? It is very difficult to time market tops or bottoms due to the psychological nature of market cycles. As we have seen when looking at historic bubbles they can stretch on for years before they reach their peak. As they say on wallstreet: the market can stay irrational longer than you can stay solvent.



In the past the yield curve has been a great leading indicator to detect a recession ahead. Of course there is no guarantee this will be predictive again but there is a good chance since ultimately it is down to smart investor behaviour. In any case watch out for the yield curve inverting as a warning signal.


Nobody knows what event or chain of events will cause enough market participants to panic sell and trigger a crash. However being aware of these cycles and roughly what part of the cycle we are in allows you to manage your portfolio in a way that you can make money instead of loosing it. As promised lets look at how to do exactly that.
Lets assume that your portfolio is already well diversified. Now your goal is to maximise your profits and minimise your risk therefor you want to have liquidity available to buy into a crash and at the same time protect your existing portfolio from losses. There are different ways to do this but my preferred way is to keep taking profits on a regular basis on all my positions. The resulting profits are partly held in cash or liquid inflation protected assets and the other part is used to build a position that is going long volatility.


The current market has very low volatility. The only way is up and there are only minute corrections to the downside that are immediately bought up. This means the VIX a measurement for volatility is trading at relatively low levels. A big correction or crash in the overall market will lead the VIX to spike up. Thus going long volatility while buying the VIX with futures, options or ETF's earns our portfolio excellent protection from the crash.




If you balance the VIX position and your portfolio out correctly you can easily cover all losses with the VIX position all the while being liquid enough to buy into the crash in order to profit from the recovery that inevitably will ensue.