The EconomistAugust 22nd 2020 Finance & economics 632
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pon beingsucked into investing
during the South Sea Bubble, Sir
Isaac Newton reflected that he could
“calculate the motions of the heavenly
bodies but not the madness of people”.
From tulip mania in 17th-century Am-
sterdam to railway fever in Victorian
Britain, history is littered with tales of
investors who lost their heads shortly
before they lost their shirts, in the grip of
mass delusions described by Alan Green-
span, a former chairman of the Federal
Reserve, as “irrational exuberance”.
These delusions seem obvious with
the cold clarity of hindsight. Spotting
them in real time, however, is trickier—
especially when the usual measures of
frothiness are out of action. Wall Street
types typically pore over price-to-earn-
ings ratios, which compare a firm’s value
with its profits, or free-cashflow mea-
sures, which look at the cash firms crank
out after investment. Warren Buffett
targets firms with a high return on capi-
tal, which compares their profits with
the size of their balance-sheets. But the
covid-induced economic slump has
caused earnings to sink even as the Fed
and other policymakers have helped
buoy share prices. The obvious gauges of
frothiness are not much use.
This poses a problem for investors
confronting the startling fact that the
s&p500, a share-price index of America’s
biggest public companies, reached an
all-time high on August 18th in the mid-
dle of perhaps the sharpest ever eco-
nomic downturn. Without hard numbers
to count on, they must interpret the
market’s unusual behavioural signals in
order to spot the froth.
One such sign is the mystifying
moves in some stocks. On August 19th
Apple became the first American com-
pany to touch a valuation of $2trn. Tesla,a carmaker that is undertaking a stock split
at the end of August, has quadrupled in
value so far this year. It is now worth
$354bn, more than Ford, Toyota and Volks-
wagen combined. Nikola, an electric-truck
firm (that has yet to make any lorries), has
tripled in value since May. Even more
perplexing was investors’ fondness for
Hertz, a car-rental firm. Its share price rose
tenfold after it declared bankruptcy
(though this bubble has since popped).
Anecdotally at least, this frothiness
seems linked to a second phenomenon: a
zeal for retail investing. Take, for instance,
the popularity of Robinhood, a trading
platform, which has opened 3m accounts
since the end of 2019, taking its users to
13m. Or consider “r/wallstreetbets”, a
forum on Reddit, which encourages its
readers to make “yolo” (you only live
once) bets on short-dated speculative
options (akin to lottery tickets) in order to
earn “tendies” (short-term gains). The
number of subscribers to it has nearly
doubled since January to over 1.4m, edging
out its staid cousin, “r/investing”, which
preaches the virtues of punting on div-ersified baskets of low-cost index funds.
That exuberance has been matched by
a third behavioural oddity: companies’
enthusiasm for issuance. Dealogic, a data
provider, finds that stock issuance in
America has jumped by 85% year-on-
year so far in 2020. Part of that may be a
result of the pandemic; many companies
have raised capital to build up war-
chests. But issuance is also compelling in
bubblier times, because it allows firms to
capitalise on lofty valuations. Hertz tried
to raise up to $1bn in new equity after it
had filed for bankruptcy, before regu-
lators intervened.
Moreover, after a hiatus in the first
half of the year, tech firms are rushing to
list. Special-purpose acquisition compa-
nies (spacs)—listed shell companies that
then merge with private firms, offering a
speedy, back-door route to going pub-
lic—are all the rage.spacs were once a
dirty word on Wall Street, thought fit
only for firms unworthy of an initial
public offering. But now they are in
favour with firms and investors. They
have raised $12bn so far this year, just shy
of the amount raised in all of 2019.
What to do, in the face of all this
enthusiasm? Other assets may start to
seem more alluring. On August 14th
Berkshire Hathaway, Mr Buffett’s in-
vestment firm, said that it had sold
chunks of its stakes in banks and bought
up shares in Barrick Gold, a mining
company. But gold and other assets have
also shot up in value this summer.
As markets rise further it may become
even harder to resist joining the fray.
Some investors may pile in, and exit with
a profit. But even the most brilliant
minds can be bamboozled. Sir Isaac
spotted the bubble early and liquidated
his holdings—only to be sucked back in
at the very peak.Bubble-hunting has become more art than scienceapparent conservatism, though. It is gradu-
ally reversing some of its extraordinary
past interventions. In order to maintain an
undervalued currency, the pbocprinted as
much yuan as needed to buy the foreign
currency streaming into China. To prevent
that newly created money from causing in-
flation, it then had to soak much of it back
up, or to “sterilise” the inflows. It did that
primarily by jacking up reserve-require-
ment ratios for commercial banks. At the
peak in 2011, banks were forced to place
21.5% of their deposits at the central bank.
After repeated cuts, including two sincethe coronavirus outbreak, mid-sized banks
now need to set aside only 9.5% of their de-
posits, freeing them to lend more. Coupled
with targeted liquidity injections and old-
fashioned moral suasion (a powerful tool
in a largely state-owned financial system),
the pboccan support the economy without
dramatically scaling up its balance-sheet.
Still, the very stability of that balance-
sheet has led to questions about whether it
may be accumulating foreign-exchange re-
serves on the sly. The main reason for sus-
picion is that even as China has notched up
huge trade surpluses ($62bn in July, justshy of a monthly record set in May), its re-
serves have barely budged. But a focus on
trade overlooks the cash that has left
through other channels. In the second
quarter, net financial outflows (excluding
direct investment) soared to $104bn—
equivalent to two-thirds of trade earn-
ings—partly thanks to mainlanders punt-
ing on stocks in Hong Kong. This points to
one more way in which the monetary sys-
tem looks more normal—it is becoming
fiendishly complex to monitor all the cash
criss-crossing China’s borders as, little by
little, it opens up its capital account. 7