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Stocks are booming, so beware the bust
One of the defining characteristics of an asset bubble is that most professional money men know one when they see one, but on the “greater fool theory” – the belief that when making a questionable investment there is always some idiot willing to pay even more – are very reluctant to leave it.

The point was tellingly made at the height of the credit bubble by Chuck Prince, back then chief executive of Citigroup, when he remarked that “when the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

Prince was soon to pay with his job for still being on the dancefloor when the musicians packed up their bags and left. Though it was obvious that the party was wildly out of control, he still couldn’t help himself. It was even more obvious during the tech bubble of the late 1990s, but that didn’t in any way impede the phenomenon either. A bubble may be self-evident, particularly with the benefit of hindsight, but who’s to say when it will end?

With equity prices again hitting new, post-credit-crunch highs – the FTSE 100 is nearly back to its turn-of-the-century peak, and the US S&P 500 already is – the old question has arisen anew: are we once again in bubble territory? Nor is it just equities. Despite the still anaemic outlook for advanced economies, everything seems to be going up again, from bond to house prices.

Normally, such a return of “animal spirits” would be indicative of better times ahead, yet there is today a rather more ominous explanation – it’s called central bank money-printing. This flood of artificially created liquidity is causing a surge in asset prices which, particularly in Europe, with its unresolved currency crisis, seems ever more divorced from economic reality.

Even those with skin in the game say they have rarely seen an equity market rally with quite so little conviction behind it as this one. Shares may be rising simply because of under-utilised liquidity looking for a home, and if that’s the case, then there is a big shake-out to come if and when the printing presses are turned off.

That point may arrive sooner than markets imagine, with growing concern among central bankers about the unintended consequences of their easy money policies. The famous “Greenspan Put” still stands as a salutary warning to all. Despite observing “irrational exuberance” in share prices as far back as 1996, Alan Greenspan would answer each setback with another flood of cheap money. As one bubble deflated, the former Federal Reserve chairman would merely inflate another, thereby helping sow the seeds for today’s catastrophic banking crisis.

Central banks seem stuck on a treadmill all of their own making. If they try to limit the supply of cheap money, they risk creating another financial and economic crisis, triggering yet more in the way of accommodative policies to ease the pain. There seems no way back to “normal” interest rates.

That’s not to say there is no basis for renewed optimism. The US economy may have reached what is sometimes called “escape velocity”, or the point at which the artificial recovery driven by loose monetary and fiscal policy gives way to a real and self-sustaining upturn underpinned by robust private-sector demand. The outlook for the UK economy is also beginning to look a little more encouraging, though no one would yet say that of the eurozone, which is trapped in a contractionary vortex from which there appears to be no escape.

What is more, equity markets display very few of the characteristics most commonly associated with asset bubbles. Shares look somewhat over-valued by historic standards, but not wildly so compared to previous market peaks. Initial Public Offerings, which normally mushroom in the latter stages of a bull market, remain extremely subdued, and nor is there any sign of the takeover boom normally associated with a market top. Trading volumes are low, and so too is appetite for equities among retail investors, whose propensity to buy at the top and sell at the bottom never ceases to amaze.

Yet all this is also consistent with a market pulled up by strings, without any real substance to its ascent. Before condemning the whole thing as a drug-induced mirage, it should none the less be pointed out that there is a sense in which this is the whole point of “quantitative easing”.

By printing money, the central bank eventually makes holding cash deposits or sovereign debt so unattractive that it forces investors up the yield curve into higher-risk, productive assets, eventually causing the economy to splutter back to life. The problem is that though there is quite a bit of evidence of speculative search for yield, there appears as yet to be very little impact on the real economy.

True believers say output will eventually follow, justifying the rise in equity prices. Maybe they are right, but it sure is taking its time. The Bank of England has bought assets to the value of a third of annual GDP since turning on the printing press more than four years ago, and whereas this has put a rocket under asset prices, it’s not obviously done much for the economy.

Sell in May and go away, goes the old stock market saw. It proves wrong as often as right, but for the past four years it has actually been right. In any case, if not already aboard the equity market bandwagon, now may not be the best of times to join it.

Contrarian view: watch Andrew Bell of the Witan Trust on the FTSE.

Äë˙ ďĺ÷ŕňč


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