The 2008 financial crisis was one of the world’s worst that we have seen in history. It punctured the global economy. It left people without money. In fact, the seemingly “sudden” crisis had really been brewing for a few years. Several years before the traumatic crisis, America’s housing sector was soaring high. The home prices were witnessing a yearly appreciation by 10, 15, and even 20% – all signs of the housing boom. This gave homeowners a prime opportunity to refinance their mortgages and take out cash to purchase other “important” things.
This increased trading activity proved to be even more beneficial for the already soaring overall economy. No one considered paying attention to the impending disaster. Within the short time after the housing market was inflated, the sector collapsed. Banks dealt with an increased rate of insolvency and the world witnessed a global recession.
“History May Not Repeat Itself, But It Sure Does Rhyme” – Mark Twain
Over a decade has been passed since this devastating market crash. While society has recovered from this crisis, financial experts have speculated that similar market bubbles – capable of having a grave impact on the economy – are still brewing. Once again, much could be lost if investors don’t pay attention to the warning signs.
That brings us to an important question: what are the next market bubbles? Financial gurus have dubbed the auto market and ETFs as the next market bubbles that could potentially sink the economy. Recently, when the economy was horribly hit by the COVID-19 outbreak that led to the worldwide lockdown and temporarily diminished financial activities, it is essential to have a clear understanding of the market bubbles that may be gradually forming.
The two most talked about market bubbles are as follows:
- The auto loan market bubble
- The ETF (exchange-traded funds) bubble
Let’s explore what led to the creation of these two bubbles and how our current practices may lead us to an inevitable financial calamity.
ETFs Market Bubbles
The present state of the economy has lent way to a “buyback economy.” Under this theory, big firms convert their equity into debt. This approach is dangerous because it has no regard for future growth and is more focused on present consumption. In addition, this common mechanism is also a veiled attempt at curtailing the money in the hands of a few – which include wealthy investors, Wall Street financiers, and corporate executives.
This also halts the growth of a company and the economy as a whole. Imagine having a huge amount of funds and, instead of using them on the innovation of your product, investing it in your stocks. This equity could have been used for job creation, market research and other related business activities. However, because of the fact that investment in stocks can be done at a lower cost, many people are in favor of the buyback economy.
Apart from the lack of innovation that this financial activity leads to, it also raises concern. The market leadership has also shrunk and there now, there are only a few big companies that have taken up the majority of space in the market. Because of the frequent buyback offered by these companies, many investors are more prone to investing in the stocks of limited companies like Facebook, Amazon, Microsoft, and Apple. Other stocks may miss an investor’s radar, leaving the accumulation of assets primarily in big companies.
In addition, there has been an unprecedented rise of Exchange-Traded Funds (ETFs). ETFs are like mutual funds in the sense that it contains a collection of stocks. However, under this investment strategy, the investors can invest the money, and take it out, at lightning speed. They were designed to be traded several times a day, if desired. The huge influx of money into these funds has distorted the value of bonds and stocks. Now, these stocks are grossly overvalued, potentially creating a bubble. Many experts fear that in our recent post-economic “V” shape recovery after COVID-19, investors may be dumping too much stimulus money in the market. There has been speculation that, once interest rates start ticking up, investors may be spooked at the uncertainty and may liquidate their holdings once they start seeing volatility. According to the Shiller’s Price Index of March 2020, one of the ways the industry monitors the Stock Market to see if it is overvalued, the U.S. market’s CAPE ratio exceeds 36 times earnings. Even though this is not the clear indicator that the stocks will crash, it does indicate that not all is well in the stock market and the stocks have little room to grow. Many financial experts may have the opinion that when the bubble finally bursts, the impact may be even more severe than the initial effects of the Coronavirus on the economy.
The Auto Market Bubble
The auto market has been challenged for a long time now. In 2018, we saw the market had a drastic decline in the sale of used cars. This was considered the biggest drop since 2009. Now, we are witnessing a lack of auto production due to shortages in microchips and rubber due to a huge demand and limited supply. A quick research of the market also shows that delinquent subprime auto loans have been increasing at a rapidly fast pace. In fact, auto delinquencies are higher than what they were in the last recession, raising concerns for people. To top that off, we are seeing 7 month loans on car with zero interest. How long can a business, much less an industry, sustain itself for very long when they are giving away money?
It is also important to note that challenges in the auto market started to emerge when the economy was lauded for doing well. However, it is also important to note that Economists may believe that the damaged caused by a dip in the auto market will not be as severe as the housing crisis, mainly because auto vehicles are of low value.
In a world post-Coronavirus, with the rate of unemployment bouncing back at a fast pace, car loan payments have been largely affected. Many financial institutions have their business model based on car loans. While the economy has been improving and is still expected to have another boom when the majority of the population becomes vaccinated, banks may still have to delay the payments by at least 120 days. We are still emerging from yesterday’s Coronavirus-led recession and we are not out of the woods yet. The question is how long will it take for everyone to become employed again and will these institutions be able to maintain their revenue when car loans payments will be at their lowest?
Even in our improving economy, the rising trends show that not all is well for the auto market. It isn’t an exaggeration to say that there could be an auto loan market meltdown unless we see government intervention. Based on the steps taken with the stimulus bill, the Fed and our government seems more than happy to think short term, not long term, choosing to spend their way out of a recession and continue to drive up our National Debt.
The Final Word
People who closely watch and study the ever-changing market trends often wonder if there is a way out of an impending financial crises. The 2008 financial crisis is still fresh in the memory of some people. Having been through one of the worst recessions in the history of the world, we can only hope we have learned from those mistakes. While recent government policy has proven government is more than happy to step in and help, how far are they willing to go? Will it be at the expense of incurring even more debt? And the next question is, who will be paying that debt? Where will the money come from? Could the simple answer mean higher taxes for the everyday tax payer?
To invest in an upward, rising market may put you in a good financial position, but through all of this, it is also important to tread carefully and read the warning signs we have been seeing in the markets.