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Will the ASX see a share market bubble in 2021?

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Will the S&P/ASX 200 Index (ASX: XJO) see a share market bubble in 2021?

Well, 2020 was certainly a year of surprises. Many investors believed that the onset of the coronavirus pandemic would result in (at least) a year of severe haemorrhaging for ASX shares. That, of course, did take place back in March and April. But ASX shares quickly rebounded and ended up finishing the year essentially flat. That’s a deal I’m sure most investors would have taken with both hands back in March.

Over in the United States, the reaction was even more positive. The S&P 500 Index (INDEXSP: .INX) was up more than 16% for 2020 despite America being arguably one of the hardest-hit countries around the world. In the latter half of 2020, things turned exuberant across these 2 markets. We had a number of ‘winners’ from the pandemic booking massive share price moves.

Take buy now, pay later (BNPL) pioneer Afterpay Ltd (ASX: APT). Afterpay appreciated more than 300% in 2020, driven by the shunning of cash that the pandemic brought forward, as well as several other tailwinds. These include its partnership with Chinese e-commerce giant Tencent Holdings, as well as a series of stellar earnings reports.

Over in the US we saw similar, if not more potent, trends. Growth stocks like Tesla Inc (NASDAQ: TSLA) and Square Inc (NASDAQ: SQ) exploded in value, driven by a cocktail of both sentiment and results. We also saw frenzied speculation in both ‘vaccine stocks’ like Moderna Inc (NASDAQ: MRNA), and ‘pandemic losers’ like Hertz Global Holdings Inc and Carnival Corp (NYSE: CCL) in almost equal measure. IPOs like AirBnb Inc (NASDAQ: ABNB) saw stock prices double on initial trading.

2021: bubble or boom?

Such behaviour is often described as the early signs of a stock market bubble. So is that what 2021 might eventually bring us?

According to reporting in the Australian Financial Review (AFR), one investor is warning that we are in a bubble “that will eventually burst”. That investor is Roger Bootle, chair of Capital Economics. Mr Bootle quotes another legendary investor, Jeremy Grantham, who has recently warned investors of “bubble-like conditions”, calling the current state of the US markets “more overvalued that the eve of the great crash of 1929”.

Bootle agrees with Grantham that “while the economy has floundered, the share market has continued moving upwards so that it is now far higher than it was before the pandemic hit”.

Pop?

So when will this bubble burst? Well, that’s the $64 trillion question. Like many commentators, Bootle says that the emergence of inflation, which will result in interest rates finally rising above zero, is likely to be the catalyst. But Bootle points out that Grantham stated that “investors are playing chicken with interest rates”.

Even so, Bootle has hypothesised that central banks around the world might wait for inflation to pick up substantially before raising said rates:

I suppose that governments and central banks would initially try to take other measures to restrain inflation in the hope that they could avoid raising interest rates. But in the end this would not succeed. At some point in the future there lies not only an upsurge in inflation but also an increase in real interest rates, feeding through into bond yields. As and when this happens, it would undermine equity valuations.

He says that this initial stage will give asset prices (like ASX shares) an even bigger boost before the inevitable rise in rates brings things back to earth. That might or might not happen in 2021, but Bootle is pretty confident it’s a ‘when’, not an ‘if’.

Not such a Happy New Year from this commentator!

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Sebastian Bowen owns shares of Tesla. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Square and Tesla. The Motley Fool Australia's parent company Motley Fool Holdings Inc. recommends Carnival. The Motley Fool Australia owns shares of AFTERPAY T FPO. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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