Is The Fed Inflating an Asset Bubble?
These days it’s hard to be a stock market optimist. As the Canadian Couch Potato points out, people are scared of stocks whether the market is up or down. Everyone has a half-baked idea about how some economic indicator is forecasting doom. One of these has actually gotten my attention at times. With the policies of central banks driving down interest rates, are they causing the prices of assets (such as stocks) to rise to unsustainable levels and lowering future returns?
This is entirely possible since low interest rates make the economy look good, help companies make more profits, and allow investors to borrow to buy stocks. Rising interest rates give you the opposite of those effects. So there is a reason to be cautious.
However after looking at other information this is far from a clear picture. First, the valuations of stocks are reasonable. If the P/E ratios of major indexes were pushing above 25 that would be a real cause for concern, just like when buying a house is unaffordable compared to renting (see: Vancouver). But we’re nowhere near that point yet.
Second, as the post linked above points out investors continue to flee stocks. And they’re still buying up bonds that pay an insultingly low yield, even a negative real yield in many cases and a negative nominal yield in a few cases. It seems like this is perhaps a bigger driver of the market right now. With everyone trying to rush for the exits in the stock market, we would still be in the middle of a big asset crash. Central bank policies may be propping up the stock market but I don’t think the effect is unreasonable at this point (I wouldn’t argue with a nice 50% crash next month of course).
If the economy recovers to a state similar to where it was 10 years ago, the central banks may be able to quietly withdraw the pressure they’re applying now without disturbing the balance, once investors are confident enough to support assets prices on their own. Or if we move permanently to a new, lower level of growth, asset prices might just stagnate or slowly decline as the central banks keep intervening.
Either way I still believe there’s a good chance that at some point in the next few years investors will flip a switch and pour massive waves of cash back into the stock market (well after it’s recovered of course), driving prices to true bubble levels.
Let’s hope bonds crash before then so there’s at least one good asset class to move into.