Dot-com bubble 2.0? Dr Richard Smith, chairman for the Study of Cycles

US-based investor Dr Richard Smith unpacks the implications of a persistently higher inflationary environment and rising interest rates on the financial markets, with a particular focus on US equities. A Goldilocks era for equity markets seems to be coming to an end. The Fed is taking a more hawkish stance as the economic indicators have been flashing red. Inflation, the primary threat to equity markets, has been a major headwind for emerging tech, the high-growth businesses that were the standout winners at the start of the pandemic. Dr Smith emphasises the importance of understanding the behavioural dynamics of investing, especially during market downturns. He says that given human nature hasn’t changed in the last 20 years and valuations are at their highest levels in history, a market crash such as the dot-com bubble can be repeated. – Justin Rowe-Roberts

Dr Richard Smith on the sentiment in the US regarding the health of equity markets:

People who are looking at it deeply, definitely have some concerns. I think the biggest concerns have to do with the trajectory of inflation and long-term interest rates. Certainly, from the perspective of the Foundation for the Study of Cycles, we see a lot of indications we are at a major cycle bottom in terms of yields on long-term interest rates, and we definitely expect yields to rise. And that has been the major trend for the past 40 to 50 years, frankly. We’ve expected them to rise earlier as a lot of people have. I was looking at a quote from Alan Greenspan in 2005, saying it’s kind of a conundrum why long-term interest rates aren’t rising, right? We are at a turning point. Inflation is picking up, it’s here to stay and long-term rates are rising. We also have to think about real yields; you’re earning interest on long-term bonds versus what inflation is. Those are negative. I suspect they are going to stay negative. I believe both inflation and long-term rates are going to rise, and the reason they’re going to stay negative is that the government and the Federal Reserve are pursuing a policy of what is called ‘financial repression’. Which means they’re using the private sector to help pay off their debts. 

On value vs growth in 2022:

Well, it’s definitely negative for growth companies. And let’s face it, growth has been the story of the past decade. So, value will be more attractive than growth over this year. For sure. Inflation can be good for equities. Especially companies that can raise their prices. Inflation means you don’t want to leave your money in the bank. We are not getting to the point that savers are going to be, you know, giddy. People are still going to need a place to put their money where it can grow. That favours equities to some degree and value equities, in particular, and even emerging markets. South Africa isn’t in a bad spot. And, by the way, I commend South Africa on your management of Omicron and alerting the world. I think you guys have earned some cred over the past few months. 

On whether this time is different to the dot-com bubble:

This time is no different. You are going to have a lot of people who got involved in the markets in 2021 and know nothing, but gains are going to start to understand the pains that the markets can deliver. These market cycles have been going on for probably as long as there have been markets, certainly for as long as we’ve been able to track markets for the past 100 years or so. I don’t think there is such a thing that this time it’s different because a lot of market behaviour is driven by human behaviour, and human behaviour has certainly not changed. These are the kind of traps that we get ourselves into in markets, and we all have to pay attention to [understand] these behavioural dynamics of markets. It is also society. We have a lot better understanding today of behavioural psychology and how it drives markets. Most of that understanding, unfortunately, is being leveraged by profit-making institutions that want to manipulate human behaviour for corporate profits or government control. Meanwhile, we need to understand our own behaviour better. We need to take that into consideration in terms of how we participate in markets; we [must] not let ourselves be led astray by the behavioural manipulations in the media and in markets that really aim to extract money, attention and data from us. We have to be savvier in that regard.

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