The New York Times points out that just about everything on Earth is expensive by historical standards. And then asks the seemingly obvious question: Does that make it a bubble?
Welcome to the Everything Boom — and, quite possibly, the Everything Bubble. Around the world, nearly every asset class is expensive by historical standards. Stocks and bonds; emerging markets and advanced economies; urban office towers and Iowa farmland; you name it, and it is trading at prices that are high by historical standards relative to fundamentals. The inverse of that is relatively low returns for investors.
“Quite possibly?” We’re not sure what definition of the word “bubble” they’re using. But in our book when the price of literally everything blasts upwards, obliterating the previous ceilings of historical benchmarks, it’s a pretty good indication that you’re in a bubble. Call us cocksure if you must.
Aside from their apparent struggle with the obvious answer, the Times does correctly identify the problem: (And we give them extra points for the use of the words “thin air”).
The phenomenon is rooted in two interrelated forces. Worldwide, more money is piling into savings than businesses believe they can use to make productive investments. At the same time, the world’s major central banks have been on a six-year campaign of holding down interest rates and creating more money from thin air to try to stimulate stronger growth in the wake of the financial crisis.
Want to buy shares of American companies? At the current level of the Standard & Poor’s 500 index, every dollar invested in stocks buys you about 5.5 cents of corporate earnings, down from 7.4 cents two years ago — and lower than just before the global financial crisis in 2007-8.
Prefer a more solid asset? The price of office and apartment building has risen similarly; office space in central business districts nationwide costs $300 per square foot on average, up from $147 in early 2010, according to Real Capital Analytics. In Manhattan, an investor in an office building can expect rent payments after expenses to add up to only a 4.4 percent return, known as the capitalization rate, lower than even in 2007, the top of the last boom.
What about overseas investments? Spain and other Southern European countries that were the nexus of the European debt crisis are not the only places where bond rates have plummeted (even Greece was able to issue bonds at favorable rates earlier this year). Emerging markets, which generally have higher interest rates because of higher inflation and less political stability, are offering record low interest rates as well. Bonds issued by the governments of Brazil and Malaysia, for example, are currently yielding only around 4 percent.
The high valuations now aren’t as extreme as those of stocks in 2000 or houses in 2006; rather, what is new is that it applies to such a breadth of assets. In 2000, when the stock market was, with hindsight, a speculative bubble, other assets like bonds, emerging market investments and real estate looked reasonable.
The Everything Boom brings obvious economic risks. In the most pleasant outcome, global economic growth would pick up, causing today’s expensive assets to begin looking more reasonably priced. But other outcomes are also possible, including busts in one or more markets that could create a new wave of economic ripples in a world economy still not fully recovered from the last crisis.
Global central banks have been on an unprecedented campaign of trying to stimulate growth through low interest rates and of buying assets with newly created money. If the Federal Reserve keeps its short-term interest rate target near zero until next year, as most officials of the central bank expect, it will have maintained the zero-interest-rate policy for seven years. The Fed held $900 billion in assets in August 2008; now that number is $4.4 trillion and counting, with the third round of asset-buying set to expire at the end of the year. Central banks in Britain, Japan and the euro zone have pursued similar policies.
If this analysis of the world is correct, investors have an unpleasant choice: consign themselves to returns lower than the historical norm, or chase evermore obscure investments that might offer an extra percentage point or two of return.
So yeah… that’s what we call a bubble. And in our humble experience, those who play that game are going to get destroyed when prices revert to the mean. And by the way in case you don’t already know, prices will revert to the mean. Why? Because math.
What do we think of the “everything bubble”?
Should you buy-in to the everything bubble?
If we may offer an analogy: Right now you’re standing on a beach and all the water has mysteriously receded leaving miles of beautiful, previously unexposed sand. You can marvel at how the beaches seem to be multiplying before your eyes, or you can do yourself a favor and look into the distance at the tsunami getting ready to obliterate your village. When the beach gets really big all of a sudden, it’s not a trend you should bank on.
That’s what we think of the “Everything bubble”. Ultimately it’s a coordinated effort by central banks to devalue currencies. When the price of everything rises, it’s really the price of capital that’s decreasing. Those without assets (mere wage-slaves) are getting poorer by the minute. Those with assets are rising to the levels of a master class.
What’s important to note are two additional things:
First, the Federal Reserve has now openly stated for the first time that they do not view managing (or deflating) bubbles to be part of their mandate. If our principal monetary authority will not take on the responsibility of the largest and broadest bubble in history (even though it is entirely their creation) then it’s collapse will without question be disorderly.
Second, no bubble lasts forever.
Ergo, this will and must end — and when it does it will be disorderly. Unless of course, the Fed is simply covering their rear-end. A possibility we will discuss in an upcoming post.
When will it come crashing down? Market timing is a fool’s game. But interested readers may want to take a look at rolling returns, which paint a grim picture.