Market Watch: The three conditions for stock market mania - are we there yet?

Trader Peter Tuchman on the floor of the New York Stock Exchange in March as Covid-19 crashed markets. AP Photo.

The necessary conditions for an asset bubble are falling into place, says Pie Funds chief executive Mike Taylor.

The sharemarket has roared back since the Covid crash in March, erasing most of its losses despite the world facing a dire economic outlook.

That's raising concerns that we may be facing a "market mania" artificially inflating values into bubble territory.

"In order to blow an asset bubble you need three conditions," Taylor said. "You need easy money, We've seen interest rates drop to zero … so we have the conditions of free flowing credit."

The second thing was "something for people to get excited about".

Since the Covid crash that role was being filled by the big tech stocks like Amazon, Tesla and Netflix.

The third thing to create a bubble was a "herd" mentality, Taylor said.

That was evident where share investing crept into everyday conversations.

"So, people talking about it at the barbecue and saying how much money they've made on the stock market."

The return of retail investors was being driven, at least in part, by the rise of easy-to-use investing apps like Robinhood in the US and Sharesies in New Zealand.

These allow people to trade shares easily and directly from their phones and have been responsible for a big surge in interest from younger retail investors.

For example the ownership of something like Tesla shares via Robin Hood has skyrocketed to more than half a million investors.

Mike Taylor, founder and chief executive of PIE Funds. Photo / Supplied

But while these trends are something to watch closely Taylor doesn't believe we are yet into the danger zone.

"We've got the conditions to blow a bubble and to create mania, but we haven't done it yet," he said.

"We could quite easily, in the next one to two years, get into a situation where those household name stocks become ridiculously over-valued."

Normally what bursts a bubble is rising interest rates.

Taylor said his confidence we wouldn't see the bubble burst soon was founded on expectations that interest rates will remain on hold "for at least the next year".

The other indicator of a bubble ready to burst was extreme price spikes.

"Typically when you get to the end of a bubble or mania phase valuations go extreme," he said.

"If you look at the Nasdaq in the last nine months of 1999/2000 period, it went up something like 100 per cent."

"We haven't seen that yet. We're not there yet but I think we have the conditions for it to happen."

Meanwhile, the latest US earning season had proved relatively strong, but only in the context of low expectations set due to the Covid economy, Taylor said.

"Profits for the quarter are expected to be 43 per cent lower than they were last year, with revenue down about 10 per cent. What that's meant is Wall Street has got into a habit of lower expectations almost too far. So they've set the bar quite low."

- The Market Watch video is produced in association with Pie Funds.