This is how a bubble with no address looks like. A new article by The Economist focuses on a less spoken aspect of the recent potential bubble in the stock market – Unlike previous bubbles, all assets are expensive today. People cannot place their money in reasonably prices financial vehicles, because none of them is.
We keep hearing about the run of the stock market, but real estate and fixed income markets have had great runs as well, and solid investors can hardly find a safe spot for their money. This has created a unique state – we know that correction is perhaps inevitable, however, we have no idea what the trigger will be. Thus, as long as there is no immediate suspect for a bubble burst, we cannot project what could trigger a burst, so we can’t really forecast anything.
Where to look
We all see huge increases everywhere, but cannot really point our fingers to one direction like we could in previous bubbles. In 2008, we all knew where to point out fingers. The crisis was the result of a combination of rising real estate prices and sophisticated financial instruments that aimed to insure banks from lending high-risk mortgages, but in real life, did not insure anything. In 2000, the fingers were pointed at the internet stocks. Those stocks had astronomical valuations and the collapse was just a matter of time. And almost every bubble burst was triggered by an asset that was not evaluated properly, as I wrote in a post about the history of financial bubbles.
Today, in every asset you might be looking at, you would see that it is priced near all-time highs. The world stock market cap is now worth more than $88 trillion, according to Bloomberg. The world bond market is worth above $100 trillion. Even the Bitcoin market cap is now above $100 billion (luckily, not trillion…).
Why are these numbers so problematic? The world stock market cap is higher than the entire global GDP. The Nasdaq has gained more than 20% this year. In 2017. Less than 10 months. 20%! The S&P 500 and other major global indices have had their decent gains as well. Has the global economy improved this year by 20%? Obviously not. The global economy seems like it’s in a good shape, but does it justify these valuations?
The bond market is perhaps even more insane. While the stock market gains are led by top technology stocks, such as Google, Facebook, Apple, and Amazon, who are actually showing amazing growth in revenues and profits, some of the bond market gains have no connection to reality. A world where Argentina (a country that has defaulted 6 times in the last century) issues a bond with 100 years maturity and the investors do not raise their eyebrows, is a world that is on the verge of insanity. It’s all matter of appetite for risks, and this has been found in abundance lately.
Obviously, this insanity has a ground to lay on. The ground is the low-interest rates which gave started to hike slowly, some might say too slowly. So, the markets have not lost connection with reality – it’s just the reality is so different than it used to be. A decade of negligible interest rates have changed the way investors are looking at assets prices, but the fundamentals of assets valuations have not changed, and some assets are essentially doomed for correction.
The most obvious potential trigger for a correction is a monetary decision. A hike in interest rates may trigger a correction in the market. But the central banks have learned to work in cooperation with the markets, and interest rate hikes don’t come just out of the blue. Inflation pressures caused by increasing salaries in the world might force an interest rate hike, but as of today, those pressures are too insufficient to cause anything drastic.
The correction can also be triggered by some of the powerful lunatics out there. But as we’ve seen in the last few years, the markets just want to get up. They wanted the UK to stay in the EU, but they managed pretty well after the Brexit decision. They Wanted Hillary Clinton as a president, but the life with Donald Trump is smiling to them thus far.
Therefore, I still believe that only interest rates hike can cause a serious correction in the markets. And this could still take some time. But as the growth deepens in the developed economies, the inflation will probably emerge again, and the economic cycle will set the tone, as it always does. The timing is a big unknown, as it always is, but the intuition is that the market does not have a lot of gas anymore.