A recent New York Times article claimed that the world is full of asset bubbles. Follow this link to the article: http://www.nytimes.com/2014/07/08/upshot/welcome-to-the-everything-boom-or-maybe-the-everything-bubble.html?_r=0
The article and its message received a lot of play in the media and pundits debated endlessly whether there was any merit to its content. An endless parade of economists and money managers were trotted out on the most popular of the business programs to give their opinions on the article, and as is usually the case, they were across the board. So what is it? Is the world experiencing a global asset bubble?
Past is Prologue
Based on historical precedent, asset bubbles are a fact of life in financial markets, and are unavoidable. That is one point all of the pundits universally agree on. Beyond that basic premise, opinions diverge, sometimes dramatically, typically by individual motives and self interests. The definition of an asset bubble is a nebulous thing. What constitutes a bubble? Is it based on some percentage over accepted fair value? If so, what is fair value and what methodology is used to ascertain that fair value? It can get complicated fast. It seems people start to speak of bubbles more from a gut feel perspective than from a firm technical perspective. Technicians will point to charts and graphs to illustrate and define a asset bubble. Market analysts will often point to historical precedent to indicate that a bubble is forming, for example, a extended period of time between corrections in an asset class, like stocks. But oftentimes, claims that a bubble exists is simply based on a 'feeling'.
The Asset Bubbles
One of the prime culprits are bonds. The fixed income market is comprised of many types of bonds from junk bonds of low quality to high quality US treasuries. All are considered to be in bubbles but junk bonds typically get the most press as they are the most likely to default whereas treasuries are considered the least likely to default. With the Fed's unprecedented level of monetary action, it is understandable that this market looks inflated. This is one asset class that is widely regarded as in a bubble. The more heated debates surround assets like real estate, art, commodities, and stocks. The latest extreme example is that of CYNK, a technology company based in Belize, that recently garnered headlines from going from a penny stock to a $20 stock in short order, resulting in a market cap of $6 billion. This is with one recorded employee and modest assets. Trading has been halted in this stock as of July 11, 2014. CYNK is regarded more as a case of a 'pump and dump' scheme than an asset bubble.
Are All Asset Bubbles the Same?
As mentioned above, there are many opinions on the subject of asset bubbles. Most opinions seem to be a function of perspective and self interest. Many of the opinions are based on bubbles of the past compared to todays markets. In this regard, many point to extreme asset values from as a recently as the 2000 dot com stock bubble to the 2006 real estate bubble. This argument claims that today's values do not match those past extreme values and therefore preclude today's assets from being in danger of popping. Money managers that favor stocks are firmly in this camp. Their interest in seeing stock values rise and therefore their management fees rise makes their opinions dubious. In fact, the very nature of their position ironically contributes to the formation of stock bubbles. The same holds true for managers of other asset classes such as commodities (precious metals) and real estate. It is difficult to separate fact from opinion from money managers with ulterior motives. What few of these folks point out in their rebuttals of the existence of asset bubbles is the unprecedented level of Fed intervention in our current economic climate.
It is this unusual intervention that makes, what are considered today's asset bubbles, difficult to compare to those of the past. This is where I think most arguments against the existence of asset bubbles fall down. The Fed's extreme monetary policy has suppressed yields and increased liquidity prompting investors to globally search for yield and allocate funds. The absence of the Fed's intervention would cause yields to be more market driven and the level of liquidity to contract. Rising yields would limit the amount of stock buybacks that corporations are executing. The elimination of this financial engineering tool would cause the popular P/E metric from appearing to look benign compared to the past. The contraction of liquidity would reduce the amount of capital chasing assets for yield. Most money managers use low yields as the justification for high stock multiples (P/E ratio), when in reality, the artificial nature of these low yields should dispel that theory, if not in the short term, at least in the medium to long term. For this reason, not all asset bubbles are created equal and their use as a benchmark for today's asset valuations is not valid.
If and when the Fed normalizes its monetary policy (as of this writing the Fed's asset purchases (QE) are expected to end in October) yields and liquidity should adjust. Assets should re-price and their levels should fall accordingly. The delta between todays valuations and those adjusted valuations should represent the current premium in asset values.
Are All Asset Bubbles the Same?
As mentioned above, there are many opinions on the subject of asset bubbles. Most opinions seem to be a function of perspective and self interest. Many of the opinions are based on bubbles of the past compared to todays markets. In this regard, many point to extreme asset values from as a recently as the 2000 dot com stock bubble to the 2006 real estate bubble. This argument claims that today's values do not match those past extreme values and therefore preclude today's assets from being in danger of popping. Money managers that favor stocks are firmly in this camp. Their interest in seeing stock values rise and therefore their management fees rise makes their opinions dubious. In fact, the very nature of their position ironically contributes to the formation of stock bubbles. The same holds true for managers of other asset classes such as commodities (precious metals) and real estate. It is difficult to separate fact from opinion from money managers with ulterior motives. What few of these folks point out in their rebuttals of the existence of asset bubbles is the unprecedented level of Fed intervention in our current economic climate.
It is this unusual intervention that makes, what are considered today's asset bubbles, difficult to compare to those of the past. This is where I think most arguments against the existence of asset bubbles fall down. The Fed's extreme monetary policy has suppressed yields and increased liquidity prompting investors to globally search for yield and allocate funds. The absence of the Fed's intervention would cause yields to be more market driven and the level of liquidity to contract. Rising yields would limit the amount of stock buybacks that corporations are executing. The elimination of this financial engineering tool would cause the popular P/E metric from appearing to look benign compared to the past. The contraction of liquidity would reduce the amount of capital chasing assets for yield. Most money managers use low yields as the justification for high stock multiples (P/E ratio), when in reality, the artificial nature of these low yields should dispel that theory, if not in the short term, at least in the medium to long term. For this reason, not all asset bubbles are created equal and their use as a benchmark for today's asset valuations is not valid.
If and when the Fed normalizes its monetary policy (as of this writing the Fed's asset purchases (QE) are expected to end in October) yields and liquidity should adjust. Assets should re-price and their levels should fall accordingly. The delta between todays valuations and those adjusted valuations should represent the current premium in asset values.
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