#BUBBLETROUBLE

It is interesting to see new trends in investing develop. The most recent one  is “Are Stocks in a Bubble?” Such a simple word thrown around with such impunity.  Group Think  regarding “Bubbles” is a hot topic.  Stocks, art, bonds and condos in New York are all the rage.

With stocks, junk bonds and other asset classes flying high these days, the topic of “bubbles” is very much of the moment. Many people will tell you high prices reflect high future returns, and to just invest your money and go with the flow. The market knows what it is doing, they say. The market is wise.  Others tell you to duck.

The New York Times recently stated “With relatively little fanfare, the stock market has become expensive again. We obviously can’t know which way stock prices are headed.”  We agree.

On the other hand, some insane activity  has gripped the ultra luxury housing segment in New York, where within 24 hours, an overzealous seller tried to flip a $31 million three-bedroom condo at One57 purchased on May 6, to an even more overzealous buyer on May 7 for… $41 milliona $10 million price increase in one day!

“Capitalist Exploits” writes, “Risk is now underwritten by central banks, whose balance sheet liabilities have exploded. What could possibly go wrong? Haven’t I read this story before?

 

58-4mill

$58.4 Million. A steal….really!

This piece of “art” wasn’t even handmade. Nope…built in a factory.

 

Bubbles are relatively easy to identify, especially when there exists something to compare and contrast them to – a benchmark.

 

Interest rates no longer reflect fundamentals in any way. Junk bonds trade for ridiculous values, stocks, real estate, antiques, art; even classic cars seem to be trading at either all time highs or close to. The one consistent when digging into the interplay of the financial markets is a market driven by artificially low interest rates. When the price of capital is manipulated is it any surprise that we see this reflected in asset prices?”  

A legendary investor  recently penned : I estimate the market is currently overvalued by 65%, predominately because of the types of investors driving the market in the short-term.” He expects the market to go higher into the 2016 presidential elections.

Morgan Stanley’s outlook states the case rather succinctly: It’s been five years since the nadir of the great financial crisis, but the scars remain fresh in many investors’ minds. As a result, the increased crosscurrents and market volatility are being met with more fear and uncertainty than one might expect in a generally flat-performance year. Furthermore, it is the institutional-investment community that is exhibiting the most concern.

 

” As we have noted many times, this recovery has been slower and more difficult, which is exactly why the Federal Reserve has been engaged in extraordinary monetary policy like Quantitative Easing (QE). Instead of the typical two to three years, it has taken five years for this recovery to reach a self-sustaining state. The Fed, recognizing this, is winding down QE—and that has sparked a significant leadership change toward energy, materials, pharmaceuticals, industrials and large-cap technology stocks.”

The equity markets continue to remain very fragile and relatively illiquid. Remember that the majority of trading volume these days is done by HFT – high frequency trading.  The HFT algorithms can just as easily tilt to the downside as they can tilt to the upside.

I believe that as long as the perception is that the Federal Reserve will remain accommodative with its “zero interest rate” policy, assets will remain at elevated levels. When the perception changes before The Fed’s actual policy changes, the volatility will show us where the Bubbles really exist.

 

J. Brock Hamilton                                                                                                                          May 2014