A Stock Market Bubble? Or are Things Different This Time Around?

If you spend enough time in the investing world, you start to pick up on a few catchphrases along the way.

Phrases such as, “Don’t try to catch a falling knife” or “Sell in May and go away” are among the more commonly used.

Then there’s “Even a dead cat will bounce if it falls from a great height” or the ever-so-popular Warren Buffett quote, “Be fearful when others are greedy. Be greedy when others are fearful.”

For the most part, there’s a fair amount of wisdom in these phrases. After all, they often come straight from the mouths of some of the world’s most successful moneymakers.

At the same time, though, it helps to keep in mind that rarely should any one phrase be taken as gospel. I find this to be especially true whenever your finances are at stake…

To Boom or Bust?

Recently, I’ve been having difficulty reconciling two of these common bits of investing wisdom. Specifically, I’m referring to the sayings: “Past performance does not guarantee future results” vs. “The four most dangerous words in investing are: ‘this time it’s different‘.”

You see, one of these phrases tells us the markets are cyclical — economies will bubble, they’ll burst, and then they’ll do it all over again. Yet the other tells us the future is not set in stone — just because something has happened before doesn’t mean it will happen again.

When you consider the current state of the market, the discrepancy between these two schools of thought is of the utmost importance. That is, it raises the question, are we headed for another crisis, or will the good times keep on rolling?

See, on one hand, stocks are getting incredibly expensive. Investors are paying more per earnings (on average) today than at virtually any other point in history…

Click Image to Enlarge

The only other times P/E ratios have been this high were during pre-market crashes such as the dot-com bubble, Black Tuesday, and the financial crisis of 2008. If history does in fact repeat itself, right now would be a particularly dangerous time to invest.

On the other hand, things actually are different this time around — maybe not enough to end the historical boom-and-bust nature of the market, but different nonetheless.

For one, young start-ups and tech companies are generating revenue at rates never before experienced by the markets.

One look at the income statements for companies like Facebook (NASDAQ: FB), Apple (NASDAQ: AAPL), or Uber, and you begin to realize high multiples might not be that much of a concern — after all, revenue growth has long been among the most telling indicators of investor return:

Then there’s the simple idea that technological progress begets even more technological progress. A lot of people commonly mistake this for Moore’s law, but it’s more accurate to discuss it in terms of what Google director of engineering Ray Kurzweil calls “The Law of Accelerating Returns.”

In short, the Law of Accelerating Returns tells us that if you look at technological advancements over time, you’ll notice an increasing pace of change, with disruptive events merging closer and closer together.

Consider, for instance, that it took 8,000 years to advance from the Agricultural Revolution to the Industrial Revolution yet just 120 years from the Industrial Revolution to the invention of the light bulb.

It then took only 90 years to land on the moon, another 22 years for the Internet to emerge, and just nine more years for the human genome to be sequenced.

The reason for this accelerating rate of change is both a combination of accumulative knowledge and increased computing power. Combine enough data and enough processing capability with human analytics, and you end up with innovation.

The Law of Accelerating Disruption

Now, the reason I bring all this up is because as an investor, you may feel compelled to side with one camp over the other. That is, either the sky is falling and the bubble is bound to burst, or advances in technology are becoming so relentless that today’s highly optimistic valuations are indeed justified…

Yet it helps to remember the world is rarely as black and white as we often like to paint it. For instance, it might be true that the market is being overvalued as a whole, but at the same time, an accelerating rate of disruption may now provide us the opportunity to sidestep (or even profit from) the inevitable burst.

Now, I won’t get into too much detail about this today, but it all falls under the umbrella of a strategy I refer to as “Buy the Disruptor, Sell the Disrupted.”

You see, as a consequence of accelerating disruption, long gone are the days when investors can simply buy and hold for decades at a time. We now live in a world of rapid change — a place that ultimately requires a more active investment approach.

In the coming years, businesses will rise and businesses will fall at rates faster than we’ve ever experienced before. Fortunes will be made in the process, but they’ll be lost as well. In this sense, things are certainly not different this time around.

Yet it still holds true that past results do not guarantee future performance. It’s likely that because of accelerating disruption, any market bust will be incredibly short-lived. If the Law of Accelerating Returns tells us anything, it’s that the next “next big thing” will come sooner than later, and when that happens, the market tides are bound to rise again.

Now, I plan to broach this topic further at a later date, but I think we’re about nearing our limit for today. Before I leave you, though, I have just one more catchphrase to share with you…

Earlier, I mentioned that rarely should one phrase be taken as gospel when your finances are involved, but I believe this to be an exception. The quote comes from Benjamin Franklin, and it goes like this:

“An investment in knowledge pays the best interest.”

Until next time,

Jason Stutman

Check us out on YouTube!