Another market bubble hovers

2013-11-24

 

Five years of rapid-fire money printing at the US Fed and easy-money policies at other central banks have left trillions of dollars sloshing around the world financial system — and some of it is ending up in some rather odd places

 

FIVE years of rapid-fire money printing at the US Federal Reserve and easy-money policies at other central banks have left trillions of dollars sloshing around the world financial system — and some of it is ending up in some rather odd places.

 

The froth can be seen in everything from Pakistan’s stock market to thoroughbred racehorses, rare paintings and gemstones, taxi licences and the digital currency Bitcoin.

 

“When it gets like this, pick your asset. It is almost always a sign that there is too much money floating around,” said Howard Simons, a strategist at Bianco Research in Chicago.

 

Certainly, the risks do not look as great as they did from 2005 to 2007 when real estate prices in the US and other countries skyrocketed then collapsed, triggering the financial crisis.

 

The most inflated prices are in smaller pockets of the markets than they were then, so there is less systemic risk.

 

But if a series of smaller financial market bubbles deflate or even burst, there will still be a lot of agony, investment strategists warn.

 

When the Fed does pull back from stimulating the economy by cutting back its quantitative easing programme of bond buying — which is expected in the first half of 2014 — there could be some shocks for markets to withstand, said Win Thin, an emerging-market strategist at Brown Brothers Harriman.

 

“That could lead to some painful adjustments.”

 

One toxic corner of the markets can infect stronger assets as investors seek to raise cash to cope with a plunge. “What I learnt in the last two bear markets is that it does not matter if you own the crappy asset,” said Simons. “If someone else does and starts panic selling, it takes your good stuff down too.”

 

And a further bond market sell-off, following the mid-year reversal, could not only hurt investors but threaten a downturn -as mortgage rates and other borrowing costs climb.

 

As for US stocks, it is hard to find bearish investors, despite -or because of -the 26% gain in the Standard & Poor’s 500 index this year and the 166% rise since 2009.

 

In Europe, it often feels as if the continent-wide debt crisis that threatened the euro never happened. Price-to-earnings ratios have soared to 2007 levels even as earnings momentum has sputtered.

 

The dotcom stocks bubble and bust from 1998 to 2001 turned retail investors into addicts for the latest stock offerings. And things are looking a bit frothy again. So far, 199 US companies have gone public this year, the highest number since 2007, and some of the first-day gains have been huge.

 

Such a race to list was a sign that things are nearing a ceiling, said Peter Atwater of Financial Insyghts, an investment advisory firm in Pennsylvania.

 

Although the broader US market does not look too pricey — the S&P’s forward price-earnings ratio of 15 is about bang in line with the long-run average — individual stocks certainly do.

 

Look no further than some of the biggest names coming to market in recent years, such as Twitter or Tesla Motors. After almost doubling on its first day of trading, Twitteris valued at almost $24bn (about R240bn) despite being unprofitable. Tesla is trading at a price-earnings ratio of about 80 based on expected earnings.

 

Stephen Massocca, MD at Wedbush Equity Management, said: “Nobody in their right mind would make an all-cash offer at current levels for a lot of these companies.”

 

By suppressing interest rates, central banks have yield-starved investors falling over themselves to lend money to companies with less-than-stellar credit records.

 

Perhaps the best way to measure froth is to watch what the superrich do. Lately, they have developed a taste for fine art — a Francis Bacon painting set a new record when it fetched more than $142m in New York last week.

 

Even the market for thoroughbred racehorses is roaring. In Europe, a one-year-old horse that had never been raced sold this year for £5m (about R82m), a record price.

 

The association with drugs, money laundering and other illegal activities has not tarnished the virtual shine of Bitcoin, the digital currency not backed by any government or central bank.

 

The currency, whose supply has been carefully controlled, this week soared above $600 from below $80 in early July.

 

Société Générale strategist Sebastien Galy said Bitcoin was an example of “how far and aggressively greed can push a deeply inelastic market”.

 

The casino approach is not restricted to developed markets. Pakistan is nobody’s idea of a safe and predictable investment destination, but one would not know it from its stock market. Pakistani stocks have nearly doubled since the start of 2012 and are well above their levels even before the financial crisis.

 

It was another instance of the reach for yield driving political risk considerations out the window, said GFT Forex’s Boris Schlossberg. “Quantitative easing is having a spillover effect across the world.”

 

The consequences of the likely withdrawal of that support is the biggest issue for 2014. The risk is that even investors who have identified bubbles will wait too long to