Are stocks and real estate part of an asset price bubble?
Lately, I’ve been asked by many clients, friends, and acquaintances if I think we are in an asset price bubble. Should they sell their investments and their home and wait for the prices to fall before they jump back in? After all, real estate prices and the stock market are at all-time highs! In short, I do not believe this is a bubble. The present situation is significantly different from 2007-2008 recession. I believe that the current spike in asset values (stocks and real estate) is primarily a result of more money entering the system.
For most of the past 50 years, the M2 money supply (simply defined as the actual money in circulation) has increased by an average of roughly 6% per year. Only in the 1970’s and early 1980’s did we see double digit increases in money supply. Some may remember periods of extreme inflation back in those days! Even during the economic recovery and stimulus from 2008-2012, the money supply still averaged a yearly increase of only 6%. By contrast, beginning in March of 2020, the M2 money supply began to increase by double digits. By year end 2020, the money supply had increased by 26%, and through May 2021, it has increased another 5%. US households added $13.5 trillion in wealth last year, the biggest increase on record.
I believe the increase in money supply has primarily led to an increase of price for investable assets. More money doesn’t make us wear two watches at the same time or eat two lunches every day. However, we do find a use for that money, either saving it in our bank accounts or investing in other assets. With interest rates on saving accounts near zero, I believe that many people have used the extra money to paydown debts and INVEST.
The first 10 months of 2020 were…scary. Even though the money supply started to increase in March 2020, it wasn’t until the fourth quarter that the impact was apparent in asset pricing. Perhaps a lot of people were holding on to their increases in cash reserves, however, by the 4th quarter, with the vaccine a reality and an expectation of a return to normalcy on the horizon, people resumed investments. In the end, 2020 delivered stellar returns for the S&P 500, but all of the gains in the S&P 500 index from the beginning of the year occurred in the 4th quarter.
While stocks and bonds can be purchased immediately when you make the decision to do so, it takes real estate a little longer to transact. As a result, stocks were able to bounce back in the 4th quarter of 2020, while it took real estate a little longer to illustrate the pricing increases. According to the Case Shiller 20-city composite index, year over year prices have increased 15%.
In the end, it is my belief that the 26% increase in M2 money supply has created a new baseline for investable assets, specifically for valuations in real estate and stocks. I don’t believe we are in a bubble - the money supply has increased and at no point in history has it ever decreased.
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