If you turn on the TV, or read the financial press, financial pundits & investors alike are talking about “The Everything Bubble.” There are multiple stages of financial bubbles, & while each mania has its own nuances, in retrospect there are almost always commonalities that the market & market participants experience.
Howard Marks: “We Are In An Everything Bubble”
Dr. Jean-Paul Rodrigue published a widely circulated economic bubble chart in which he identified four distinct phases of a bubble, referred to as the (i) Stealth Phase (ii) Awareness Phase (iii) Mania Phase & (iv) Blow-Off Phase.
Looking at drawdowns in the S&P 500 as a proxy for “bubbles,” according to BofA we’ve had 17 different 30% pullbacks in the S&P 500 since it was created, with 4 occurring in the last 30-years (2020, 2007, 2002, 2000) where the “Blow-off” phase was catalyzed by the COVID-19 pandemic, Global Financial Crisis (GFC), the aftermath of 9/11 & the Tech Bubble.
What’s been less discussed is the mental psyche of market participants across each stage, particularly as the awareness / mania phase extends longer and longer. This is where we find ourselves today. Despite the 30% drawdown in February to March 2020, the snapback was so quick, that for most market participants it has felt like an extension of the bull market that risk assets have been in since March of 2009. Some market participants are referring to this as “The Everything Bubble.”
There are seemingly two distinct phases that we’ve transitioned between in the current “mania phase” that has been exacerbated by the unprecedented fiscal and monetary stimulus, real yields, and corresponding risk asset appreciation.
- There Is No Alternative (“TINA”) 1.0 — As signs of mania / blow-off phases begin to percolate, the early movers looked to go to cash as it was “safe.” We saw personal savings at all-time highs, corporates raised cash & suspended dividends / buybacks / M&A, etc….
- TINA 2.0- After months of negative real-yields, the mentality has started to transition to the detriments of holding cash, as the negative wealth effect has been very real, watching asset prices continue to appreciate around them, moving out the risk curve, which typically culminates in the blow-off top.
The “Everything Bubble” is overly simplistic & not fair to all parts of the market so we’re looking to disaggregate what’s causing these “bubbles” and where opportunities may be if we do see the blow-off phase.
Monetary / Fiscal Stimulus
Since the COVID-19 pandemic began, there’s been $32T of fiscal and monetary stimulus, which is the largest stimulus as a percentage of global GDP that the world has ever seen. Global Central Banks have spent $834M per hour buying bonds over that time and now ~25% of all government bonds are negative yielding, with a significantly higher percentage at negative real-yields, given inflation.
Source: Bank of America
In the US alone the Fed has bought $4 trillion of bonds in the past 18 months, while the US government is spending $875M per hour in 2021.
This is driving people further out the risk curve, and as we’ve said in the past, “QE Infinity turned your savings account into your checking account, the bond market into your savings account, the equity market into the bond market, the venture market into the equity market, while given rise to the crypto market as the new venture market.”
Real Asset Response
We’ve seen a significant appreciation in commodities with the S&P GSCI +120% from the lows last March, and commodities such as Copper +102%, Aluminium, +82%, Corn +80%, Nickel +49%, Gold +22%, etc… We saw Lumber +300% at one point (and now it’s still +20% from March ’20 levels), while the US CPI Used Car Index is +45% YoY.
If we look at the S&P CoreLogic Case-Shiller 20-City Composite City Home Price Index, the YoY move is approaching higher levels than we saw in 2004–2006 & now the median house price as a multiple of median income is at an all-time high.
Real Asset Bubble?
Are we in a real asset bubble? It depends
Commodities: As we think about the macro tailwinds around electric vehicles, policy driven decarbonization targets, and renewable energy, one of the common themes is the “electrification of everything.” There is a “Big 6” story going on in the commodity world right now between Copper, Nickel, Silver, Lithium, Cobalt, and Aluminum out of which the supply / demand dynamic is most clear for the first three. Take copper for instance, which thus far has never seen demand destruction & to-date, there are no known technologies that are able to conduct electricity other than Copper. In autos, high efficiency motors consume 75% more copper than a standard motor, EV’s consume up to 4x copper in terms of weight compared to ICE’s, and require copper-intensive charging stations. Further, renewable energy including wind & solar consume 4–5x the amount of copper compared to traditional fossil fuel generated power. So there’s a real demand driver for copper.
Compare that to something like when Lumber was up 300% in under 12 months due to a shortage that was shortly alleviated, there are pockets of froth but for most commodities the market does a good job of offsetting increased demand, by increasing supply, when feasible.
Used Cars: Used car price increases are unsustainable. Due to supply chain shortages and one-time behavioral shifts, car manufacturers haven’t been able to produce as many cars needed to fulfill demand. This is alleviating given the average ownership tenure of a car, and the easing of supply chain bottlenecks. That 2006 Ford Mustang probably won’t continue to appreciate at 20%+/yr.
Homes: Probably. The only time we’ve seen house prices go up this fast was the precursor to the housing crisis. That said we saw a material shift for the better part of a decade post the GFC, leaving the US structurally short homes, which the National Association of Realtors (NAR) pegs at 5.5M units (2M single-family homes, 1.1M units in buildings with 2–4 units, and 2.4M units in buildings with 5+ units), while Freddie Mac estimates the current shortage at 3.8M units.
From 1968 to 2000 there was an annual average of 1.5M new units, from 2010–2020 that’s been hovering around ~1.0M. But as home builders observe what’s going on with housing prices, coupled with millennials finally buying homes, you can expect supply to start to creep upwards towards that 1.5M and likely 1.8–2.0M / year which should put a cap on how high existing home prices can continue to appreciate, and even result in “down rounds” as supply once again catches up to demand.
Equity Market Response:
How have equity markets responded to this unprecedented level of fiscal & monetary stimulus? In the spirit of TINA 2.0, funds have flown into equity markets at unprecedented rates.
As of early August, Global Equity funds have seen $605B of inflows YTD, or $1.015T anualized, equating to $3.98B/day. Global Equity funds had seen $727B of cumulative inflows over the last 25 years (‘96-‘20); that’s $115M/day. 2021 is on pace to be 40% higher than the prior 25 years combined.
While we’ve seen an increase in the number of companies coming public via IPO’s / SPAC’s the number of investable companies hasn’t kept pace with the degree of inflows, resulting in re-ratings. Looking at the total market cap of stocks with P/S in excess of 20x we’ve surpassed the tech bubble high by nearly ~$1.0T.
If it feels like the market is hitting all time highs every other day, that’s because it is. We’ve had 50 all-time highs for the S&P 500 as of 8/24 year-to-date, only twice in history have we seen this many through August; 1964 & 1995.
US Equity Market Bubble?
While bears point to all time high P/E, CAPE Ratio, etc… that fails to take into consideration the equity risk premium & where yields are. During the ‘99-‘00 period the 10-year was 5–6% vs ~1.0–1.5% today.
Looking at the S&P 500 today versus on this date (August 24th) in 1999 (arbitrary- yes) we are trading at a cheaper P/E multiple on estimated ‘21E / ‘22E EPS than where the market traded on realized earnings in ‘99-‘00, but notably the ERP was negative then as you earned a higher yield on treasuries than earnings yield on the market, whereas today that’s +3.2%-3.6%.
There are arguments to be made that the broader “fair market multiple” has re-rated higher from a mid to high teens P/E multiple that is sustainable due to several factors:
- Composition Changes- The largest market constituents today are growing faster, more profitable, with higher margins than the largest companies of ~20–50 years ago, warranting a higher multiple all-else equal.
- Ease of Diversification- The creation of ETF’s, and the ease of which investors can invest in 500 or 2,000 different companies with as little as $5-$10 can support higher multiples than a highly concentrated portfolio.
- Global Nature- The percentage of ex-US sales for large US listed companies continues to increase offering enhanced geographic diversification than ~20–50 years ago.
- Rates- As countries increase debt, they can’t afford to have real rates higher as interest would become the greatest single expenditure, resulting in a higher equity multiple all else equal.
“This time it’s different,” are always famous last words, but besides being the same “index” there’s very little in common with the S&P 500 of today and that of 30–40 years ago.
Post GFC if you look at the S&P 500 market cap divided by the Fed Balance sheet it’s almost been a flat line; “Don’t Fight the Fed.” From January 2009 until today that ratio has averaged 4.6x with a low of 3.4 (March ‘09), and a high of 6.7 (Dec ‘19); today it sits at 4.7x right in-line with that decade + average.
In a TINA world, US equities don’t scream “bubble” at current levels.
Private Equity / Venture Reponse?
The fundraising environment has been robust; whether its’ KKR or BX raising $59B / $37B during 2Q, or the $350B of capital that’s flown into APO, APRES, BX, CG, & KKR over the trailing twelve months; there’s been an insatiable appetite for allocators to put money to work in private equity.
Global PE dry powder hit an all-time high of $1.9T in January of 2021, & once those funds have capital, they need to deploy it, to repeat the cycle. Buyout deal activity in 1Q & 2Q21 set quarterly records, with $354.2B total in 1H21 across 993 deals, already surpassing 2020’s total of $257.3B across 1,429 deals. Given the public market valuations, capital from SPAC’s, and the public market receptivity to growth more broadly, the average buyout multiple hit 11.4x EBITDA in ‘20.
Venture:
We’ve seen similar activity across the venture ecosystem on the capital raise side, with firms like Index Ventures raising $3.1B a year after a $2.0B raise, Accel raising $3.0B, A16z raising a $2.2B crypto dedicated fund, etc…. GP’s have raised $74.1B year-to-date, not far from the record of $81.0B raised during the totality of 2020.
According to the Pitchbook / NVCA Q2 2021 Venture Monitor, we saw a quarterly record in 1Q21 with $75B of venture dollars deployed, & 2Q matched that record with another $75B deployed, leading to $150B in 1H21. Mega-rounds ($100M+) in ’21 have already reached an annual record high of $85.5B.
We’ve seen increased participation from “non-traditional’ VC investors, such as mutual funds, hedge funds, corporate investors, & crossover investors.
“An estimated 3,301 deals have received investment from a nontraditional institution (81.8% of the 2020 record high), representing $115.9 billion in deal value (nearly matching 2020’s total). While deal count participation rates for these institutions have only gently ticked upward in recent years, the deal value represented by nontraditionals has skyrocketed. The median late-stage deal size with nontraditional investor participation eclipsed $43 million in 2021, nearly $18 million higher than the same median in 2020.”
H1 has seen an explosion in crossover investor participation, totaling $63.5B of capital across 524 VC deals, on track to surpass $100B by year-end.
Given the amount of capital we’ve seen an increase in valuations across both early & late-stage deals. Per Pitchbook, “On the valuations front, the median and average early-stage pre-money valuation in H1 2021 has also drastically expanded to $42.0 million and $96.1 million, respectively — a notable jump over 2020’s $30.0 million and $61.7 million.”
Looking at FinTech specifically, we’ve seen a record amount of capital investments, larger deal sizes, and a notable spike in median / average valuations.
Paul Tudor Jones wrote an excellent letter last May entitled, The Great Monetary Inflation, where he outlined assets to own as inflation hedges in which he identified Gold, The Yield Curve, NASDAQ 100, and Bitcoin as the assets most likely to outperform.
“I also made the case for owning Bitcoin, the quintessence of scarcity premium. It is literally the only large tradeable asset in the world that has a known fixed maximum supply. By its design, the total quantity of Bitcoins (including those not yet mined) cannot exceed 21 million. Approximately 18.5 million Bitcoins have already been mined, leaving about 10% remaining. On May 12th Bitcoin’s mining reward — the pace at which the supply of Bitcoin is increased — will for the third time be “halved” (falling from 12.5 to 6.25 Bitcoins per block of transactions added to the blockchain). Future halvings will likewise occur approximately every four years consistent with Bitcoin’s design, thus continuing to slow the rate of supply increase and causing some to estimate that the last available Bitcoin will not be mined for another 100+ years. This brilliant feature of Bitcoin was designed by the anonymous creator of Bitcoin to protect its integrity by making it increasingly near and dear, a concept alien to the current thinking of central banks and governments.”
This turned out to be largely the right call, particularly on the Bitcoin front.
Crypto Bubble?
Now that the “market cap” of crypto is +1358% over the past 18 months & BTC is +885%,
are we in a crypto bubble? We think it’s important to bifurcate between large cap crypto vs. some of the more speculative fringe, while diving into BTC, Layer 1 Smart Contract Protocols / DeFi, and NFT’s.
Bitcoin
On Black Thursday of last year when Bitcoin sold off as much as ~50% intraday few would’ve predicted 18 months later we’d be sitting at a price of $50,000 with corporates such as Square, Tesla, and Microstrategy buying Bitcoin on their balance sheet, insurance companies like MassMutual buying $100M, wirehouse banks offering Bitcoin access to their PWM clients, or that a $1.2T infrastructure bill (crazy in its own right) would be held up as crypto lobbyists had their first taste of the Big Show, and the SEC would be showing body language that a futures-based BTC ETF might be approved (finally) in 4Q21.
As it sits here at a $900B “market cap,” BTC is behind the USD, Euro, CNY, and Yen as the fifth most “valuable” currency in the world. Through this lens you can argue that’s a stretch given the limited amount of commerce that is conducted via BTC. But the bull thesis for some time has been “digital gold” and that’s what the corporates / pensions / insurance companies / macro funds are all buying into, so fiat’s probably not the right comparison.
While we don’t have a precise estimate of the market cap of gold at current prices, a safe range is somewhere between $9.0-$13.0T which would correspond to a BTC range of $428K-$620K per BTC or up 775%-1163% from current levels. There are very few macro bets where an investor could deploy billions of dollars and have 8.5–12.5x upside with likely 60–70% downside.
Could Bitcoin go to zero and really that’s down 1 versus up 8.5–12.5x skewing risk / reward slightly? Sure. But Stanley Druckenmiller first bought Bitcoin because of something Paul Tudor Jones told him,
“Do you know that when Bitcoin went from $17,000 to $3000 that 86% of the people that owned it at $17,000, never sold it?” Well, this was huge in my mind. So here’s something w/ a finite supply & 86% of the owners are religious zealots.”
There’s a lot more “downside support” then the most vocal bears would lead you to believe because bitcoin is “backed by nothing” (despite the largest dedicated resources of compute power in the world).
What makes something a good store of value? PTJ ranks assets across four characteristics:
- Purchasing Power- How does this asset retain its value over time?
- Trustworthiness- How is it perceived through time and universally as a store of value?
- Liquidity- How quickly can the asset be monetized into a transactional currency?
- Portability- Can you geographically move this asset if you had to for an unforeseen reason?
Bitcoin scores higher than gold on liquidity / portability today, fails on “trustworthiness” due to gold’s multiple thousand year head start, but purchasing power since BTC was created skews in BTC’s favor. Below is a chart of BTC / Gold ratio.
Bitcoin bears will often point to MySpace / Facebook, or Blackberry | Nokia versus Apple, to highlight that the “first” technology doesn’t always win. That shows a fundamental misunderstanding of Bitcoin’s purpose as a store of value. You can’t replicate Bitcon’s origin story with an anonymous founder, who would be amongst the richest people in the world and ~12 years in still hasn’t sold any BTC, a fair launch with no VC’s, where anyone in the world had the ability to participate, done completely open-sourced with volunteers on a global basis, dedicated to see the “project” through, with 0 FTE, and 0 marketing budget. Subsequent attempts have been funded by venture funds, early crypto whales, with central points of failure, and known teams, which really violates that “sovereign-grade censorship resistant” property needed to compete with gold. It’s not technology that will win this, it’s security of the network & decentralization, where Bitcoin has what looks to be an insurmountable lead.
As we see a generational wealth transition from Baby Boomers, to MIllennials, Gen Z’s, and Gen Alphas, that grew up natively digital, and spend all their time in the metaverse; what store of value would they prefer? As Travis Kling puts it a “a non-sovereign, hardcapped supply, global, immutable, decentralized, digital store of value” that serves as an insurance policy against monetary & fiscal policy irresponsbility from central banks & global governments, or a yellow rock?
At a ~10% probability of a BTC / gold flippening, and the fact that you have a perpetual call option without an expiry, or theta decay, makes BTC a really compelling macro asset and at current levels hard to consider a “bubble,” even if we see another 50–75% retracement (as we already did this year).
ETH / Other L1’s
There’s been a lot of debate regarding DeFi over the past 18 months, as the total value locked (TVL) in DeFi smart contracts now sits at $80.5B up from $925M last March. We wrote about DeFi and the evolution of existing financial market infrastructure here.
ETH continues to have dominant market share in DeFi, Web 3.0, NFT, and gaming, as the leading L1 protocol, as measured by market cap, developer activity, TVL, and notional dollar value of transactions.
Is ETH in a bubble? Raoul Pal recently dubbed ETH potentially the “greatest trade” in the history of financial markets over the next six to nine months. He mentioned that ETH was set up for the “triple halving” with EIP 1559 dramatically reducing the supply of ETH by burning fees & thus burning ETH and lower fees, & the launch of ETH 2.0 with the transition to proof of stake (“PoS”). He highlights that the number of ETH addresses is growing faster than BTC’s (60% per year vs. 30% per year), and more importantly that the transaction count is growing as well. In early August ~26% of all ETH was locked into DeFi smart contracts, leaving just ~13% of ETH left on exchanges to trade. In his view, this is the perfect storm of a massive supply shock for an asset that’s exhibiting exponential demand.
We can argue that ETH faces much stiffer competition from other L1 competitors, and this is truly a battle on technology. To win DeFi, Web 3.0, NFT’s, & gaming you need to have a high performant blockchain with the appropriate trade-offs between the Blockchain Trilemma of Scalability, Security & Decentralization. Right now, ETH is working on scalability as the network can handle ~30 TPS, with block times of 14 seconds, and transaction fees range from a few dollars to a few thousand dollars depending upon congestion of the network. To onboard billions of people into Web 3.0 that’s not sufficient. Users will expect experiences comparable to that of using the internet today, where things are instant / free, with an intuitive UI/UX, and we’re definitely not there yet.
We’re not believers that there will be “one chain to rule the world,” but liquidity & therefore network effects tend to coalesce around a handful of purpose built winners for technology (e.g., AWS / Azure / Google) and trading (e.g., ICE / NDAQ / CME / CBOE) so there’s a need to put a stake in the ground. Similar to Bitcoin’s origin, ETH has benefits in that it created generational wealth for thousands, if not tens of thousands of developers who participated in the ICO, or bought ETH early on, giving them a very loyal developer ecosystem that’s incentivized to see it work. While decentralized purists will cringe when they hear this, just like when investing in companies, when investing in protocols it’s an investment on the team. Vitalik Buterin is the most well-known developer in crypto outside of Satoshi Nakomoto and for good reason. A bet on another protocol is a bet on someone not named Vitalik.
The prize for the winner of L1 protocols is likely $1.0T+, so at $375B is ETH in a bubble? If ETH 2.0 fails, sharding proves to be suboptimal, the decentralization actually gets in the way of product road map / progress, then unequivocally yes; $375B would be the 24th largest company in the world. What if they’re able to execute? There remains asymmetric upside, without having to take a binary bet due to liquidity. Underwriting ETH from current levels is either a trade in the near-term on supply / demand dynamics, or over the next 3–5 years is an explicit bet that they will execute on their stated roadmap (which has been in the works since 2016), and be one of the first & last protocols standing as it pertains to L1 value capture.
Who else has a chance as it pertains to L1 value capture? Enter Solana. There’s been a lot of talk on twitter about “Solana Summer” and for good reason as the price has increased from $24 to $70 from Memorial Day to present (August 24th) , and that’s up from under $2.00 to start the year. Packy McCormick just published a great overview of Solana that speaks for itself, but as we see it Solana is the most notable direct competitor to ETH today. Solana block times are 0.4 seconds, transaction fees are a fraction of a penny, and max capacity is currently ~65,000 TPS. You can monitor the state of the network here.
Ironically, failing to gain significant venture interest in 2017–2018 when protocols such as Dfinity, Polkadot, Tezos, Cosmos, EOS, Algorand, Dfinitiyt, etc… raised billions of dollars, was the best thing that could have happened to them. Similar to ETH, they had to ship product and build a community of developers organically. They launched their first hackathon in November of ’20 with 1,000 registrations, their second was in February with 3,000 and by May their third had 13,000.
You’re seeing real teams build on top of SOL and real transaction activity. The FTX team built Serum on top of SOL, with SBF dubbing it “the most performant blockchain.” We’ve now seen ~25B transactions on SOL since the mainnet launched in March ’20 (this includes consensus messages, so the real number is probably ~½ of that) compared to ~1.25B for ETH and ~665M for BTC. When you offer users nearly instant & free transactions, more of them occur. To be clear this is sometimes a vanity metric that earlier L1’s tried to manipulate, but utilizing your Phantom wallet, sell something on Serum for USDC, transfer it to Saber, stake it, and compare that to any other crypto experience.
Is SOL in a bubble? Given the prize to win L1, the adoption by both traditional trading firms and crypto native firms, and a growing and organic developer ecosystem, coupled with the discount to other L1’s, ETH, you can make an argument that it’s still undervalued here on a “relative value” basis, if it’s able to be one of the L1 winners.
What about other large cap cryptocurrencies?
When you look at assets like Cardano “valued” at “$90.5B” (without smart contract functionality ~4+ years in), XRP at “$54.6B,” and DOGE at “$39.1B,” it’s tough to see a world where tokenholders generate above market returns holding those assets over the next 3–5 years. It’s crypto and anything could happen, but those most certainly represent pockets of bubbles amongst “large cap crypto.”
As you move further down the list, there are hundreds of “zombie chains” with multiple hundred million dollar + valuations, countless chains where valuation is only ascribed to “circulating’ supply, and zero use cases outside of speculation. For some, that’s all you need, but over time attention drifts, and most of this is definitely signs of froth and excess in the crypto market and we expect to see significant “wealth” destruction there over the next 3–5 years.
NFTs
NFT’s have clearly made it mainstream (and had what most viewed as the ultimate contra-indicator) when there was an SNL skit in late March. While some early excess was removed from the market, since that time, we’ve seen some mind numbing NFT sales with Beeples $69M sale at Christie’s, the price of the “cheapest” Cryptopunk increasing 15x+ since the beginning of the year, Visa entering the mix with a $150K purchase re-rating the market overnight, one punk selling for a record $7.8M, with others listed “offered” at $5.5-$7.7M, Degen Apes selling out in 8 minutes despite servers crashing, and Justin Sun spending $500K for a pet rock.
Any of those things in a vacuum would seem like a “top” indicator, just as a video clip of LeBron dunking in a meaningless regular season game selling for $208K (which would be a top 4 card for him), seemed to suggest that in February for NBA Top Shot (it was to the day), or when Cryptokitties saw several 6 figure sales in Dec ’17, also marking the top.
Similar to collectables / art in the physical world, something is worth what someone else is willing to pay for it, and there will be no difference in the world of NFT’s. Owning a cryptopunk means you can afford a cryptopunk. There’s debate over whether or not this is the new wealth flaunt, such as owning a Ferrari or a Patek Phillippe, in the world of the metaverse.
Are we in an NFT Bubble? There are undoubtedly pockets of excess and just as the world of high end art, sports memorabilia, cars and watches have created generally accepted “valuation” rankings based on cultural significance, scarcity, longevity, etc… the world of NFT’s will coalesce around a similar hierarchy of value, but it’s just not there yet. Will people be able to sell “pet rocks” for $500K in 3 years? Probably not. Will the buyer of a random LeBron dunk in a meaningless regular season game be able to sell that for $200K? Highly unlikely. Will Visa be able to sell it’s “floor punk” for $150K in 3–5 years? That’s more questionable. Right now people are having fun, and as Fred Wilson put it, NFT’s sit at the nexus of “gaming, online communities, and social networks.”
We’re in the very early innings of crypto’s first real “consumer opportunity” and when you see Jay-Z put a cryptopunk as his twitter profile picture, or Paris Hilton receiving a Degenape, or the explosion of play-to-earn with Axie Infinity (so much so that it caught the eyes of the Philippine regulators highlighting the need for players ot pay income tax on the game), it’s hard to ignore the momentum of potential consumer experiences built on top of the crypto stack and right now NFT’s are showing the way.
Most of this isn’t for us, but neither is art, cars, watches, or wine. Just be careful of the market’s unrelenting supply creation machine to substantiate demand; as it’s much easier to create digital supply than it is in a physical world.
Conclusion
If global central banks and governments are going to continue to print money, investors are faced with a TINA 2.0 predicament, where cash is literally burning a hole in their pockets, pushing them not just into risk assets, but further out the risk curve, exacerbating wealth inequality along the way, leading to even further risk taking.
So are we in an everything bubble? There’s most certainly pockets of excess in nearly every corner of the financial markets, but there’s also ample opportunity.
