Eliminate Bubble Fear

by: Envoy Global Research

As this latest market sell off drags on, the worst the market has seen in quite awhile (especially if you are deeply in oil as I am), I find it best to remind myself daily that stock prices are merely abstractions for underlying businesses. So despite the heavy price declines, it is important to reflect on the business which an individual stock represents, rather than focus on prices per se. Since many people only focus on prices and not the business, price movements, including heavy declines and huge rises, become completely exaggerated.

The focus on prices, also leads to what I call: "bubble" fear. What I mean by that is that everyone remembers how tech stocks zoomed up in the late 90s and then completely collapsed in what was in retrospect one of the biggest bubbles ever in financial markets. Therefore, after the crash in 2001, investors have become very skeptical of every major increase in price in any asset class, from real estate to oil to gold.

The press and many pundits, therefore, declare a bubble whenever prices in any asset class rises dramatically over a few years. The argument is that since prices went up so much, there must be a bubble. Therefore, when a normal correction in prices happens, people get scared out of their wits that the bottom will fall out, like they did for the Internet stocks. However, this type of thinking is completely wrong, in my opinion. Prices are only abstractions, so the price rises alone cannot be evidence of a bubble, nor can price corrections be seen as sign to run for the exits. You need to focus on the underlying business.

A bubble is only in bloom when the rise in the price of a specific asset occurs when the rise is not supported by any underlying business, physical asset, and/or cash flow. With that definition in mind, you can easily see that there is a huge difference between the rise in various asset classes over the last several years, including oil and real estate, vs. that of the Internet/Telecom shares in the late 90s and early 2000.

The vast majority of those Internet stocks that went up in price and then collapsed, had no businesses. They made no money, had absolutely no assets, and in many instances were complete frauds. In addition, the bubble was really created by a small segment of the world population located in a tiny geographic area in the US. In other words, there was no real physical demand for any of the products being hawked. It was a house of cards.

By contrast oil companies (I'm ignoring real estate here because the analogy is obvious), are making huge piles of money, have a tremendous amount of physical assets, sell a product that has, is, and will be in demand worldwide, and to boot are not trading at valuations that are ludicrous, as it relates to the underlying cash-flow. Of course, there is the risk that oil prices will go down somewhat, and there is a debate at to what the proper valuation should be for oil companies, but this was and is no bubble. There are assets here, cash-flow, physical demand, and fair (albeit agreed, not cheap) valuations. And yes, it's possible that oil and oil shares, gold, real estate or what have you, have topped out for now. But that in no way, implies a collapse and a need for panic selling, unless you naively believe that people will stop using oil tommorow, stop living in homes, stop driving, and that our world leaders will suddenly begin to act in a rational and unselfish manner.

As such, in the absence of solid evidence that there is a bubble, and knowing that the stocks that I own, are supported by real businesses, with strong cash-flow potential, and solid assets, I believe that it is best to just ignore the current market sell-off, hold on to shares of solid companies, and actually buy shares in more companies which I believe represent good values.