The term “investment bubble” has different connotations to different people. Those with cash to invest in known bubbles welcome them, as there are few investment environments that offer the potential of asymmetric short term returns like a full blown investment mania. Those who either don’t have the cash, risk tolerance, enthusiasm or discipline to invest in known bubbles usually think of them in a less positive light and can’t wait for them to burst so they can sift through the rubble and pick up bargains. I am somewhere in the middle. I have traded through three verifiable investment bubbles, internet in late 1990s, real estate in the mid aughts, and let’s call it what it is, the current Fed induced risk asset bubble coming out of the financial crisis.
Regular readers know where I stand on this. The U.S. stock market is NOT a bubble in the way that we thought of the exuberance in tech stocks in the late 1990s, or real estate in the last decade, but it is my belief that the conditions for investing in risk assets are most certainly a bubble. This is a big distinction. Risk Asset prices are not where they are today because of healthy investment environment. They are here because of extraordinary stimulus measures taken to halt a crisis that would have most likely caused the deepest recession since the Great Depression. However, we’re now seven years removed and large parts of those extraordinary measures have since become normal monetary policy.
As investors contemplate the potential outcomes of the Fed ending ZIRP within a few quarters of ending QE, the question is not whether risk assets like stocks are in a bubble and will burst, but whether or not the conditions that have created a good bit of the demand for risk assets can actually be removed without causing a downshift in our already lackluster economy. Its hard to imagine that a measly 25 basis point rate hike in June or September could cause a huge stir, as many believe any move will merely be symbolic as the FOMC is cognizant of the risks of an economic rout from too much too soon.
This shouldn’t come as a massive surprise, but in a year that the S&P 500 is up less than 3%, the countries with economies that have seen the biggest declines from their peaks are seeing the most dramatic equity gains. The Shanghai Comp up 38% ytd with the freaking Shenzen Index up 60%!, Nikkei up 12%, Euro Stoxx 50 up 16% and the Bovespa in Brazil up 13%. Don’t fight the Fed… the PBOC, the BOJ, the ECB and whatever it is that sets monetary policy in Brazil.
We live in a financial Matrix. An artificial reality that most economists of the last century would think was some sort of futuristic sci-fi film. The investments you hold (for the most part, excluding your beloved AAPL) are not built on a sound investment footing. They’re built on complacency of investors who have puts in the form of every central bank in the world. I know I know, balance sheets are phenom, but re-investment (aside from buying company stock) is poor, and wage inflation at this stage of the ZIRP is a joke. C-Level suites in corporate America are hoarding cash for a rainy day that just hasn’t come, because our Fed, and its cohorts abroad just won’t let it happen.
SO where are we now? Fed doesn’t move in June or Sept and stocks in the U.S. go straight up, because there are no other investment alternatives and they need one last FU rally before we can call stocks a bubble. If they do a sort of one and done, then stocks continue to grind in a fairly narrow range as they have done for the first 4 months of 2015 until there is some sort of economic inflection point, up or down. Or we are in a topping process, and the end of QE and ZIRP will ultimately result in a meaningful pullback in risk assets, both stocks and bonds as the Fed premium will need to come out, before they are able to trade on their own merits, namely corporate earnings and a return to stable growth.
I remain skeptical of committing new cash to equities both here and abroad.