Edition #30 6 October 2010 Bubble trouble – the next global asset bubble Key points bubble and associated credit boom. Of course, housing Asset bubbles are a fact of life and flow from human bubbles tend to be a bit more constrained compared to nature which has a strong tendency to jump on to those in financial markets. But as we know, housing popular fads. bubbles and their bursting can have much bigger There is a long history of new bubbles forming from the economic & financial consequences. See next chart. ashes of the last burst bubble - and this time around is This phenomenon of bubbles seemingly begetting bubbles unlikely to be any different. Easy global money – which is getting easier as growth likely reflects a combination of the monetary easing remains sub-par in developed countries and various following a bubble burst which provides the fuel for the next emerging countries resist upwards pressure on their bubble and the desire of investors to jump into something currencies - is setting the scene for the next asset seen as safe and offering good return potential far away bubble. from the asset which collapsed in value. Potential candidates are gold and commodity prices, Major global asset bubbles over the last 30 years emerging markets and resources shares. But the 12 4 3.92 All series indexed 3.82 absence of obvious overvaluation suggests we are still Tech heavy 3.72 to 1 at start 3.62 3.52 10 Nasdaq index 3.42 in the foothills of the next bubble. (LHS) 3.32 3.22 3.12 3.02 A fact of life 8 3 2.92 MSCI Asian 2.82 Japanese 2.72 2.62 shares (ex Benjamin Franklin once said: “In this world there is nothing 2.52 2.42 6 Nikkei share Japan) 2.32 certain except death and taxes.” I would add a third index (LHS) 2.22 2.12 (LHS) 2 2.02 1.92 certainty, and that is: asset bubbles. Despite numerous 4 US 1.82 1.72 House 1.62 1.52 attempts to prevent them or regulate them away, usually 1.42 2 prices 1.32 1.22 after one bursts, they are part and parcel of free capital (RHS) 1.12 1 1.02 0.92 0.82 markets. Just as fads are a big part of the worlds of 0 0.72 fashion, music, cars and toys (I still have my Russell yoyo 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 from 1970 but the hula hoop broke), the same applies to Source: Thomson Financial, AMP Capital Investors investing. When combined with human nature to back Conditions for another asset bubble are in place something that has done well in the recent past, the outcome is a bubble in this asset or that. It’s also the case Following this pattern it would seem reasonable to assume bubbles often form in the ashes of the last bubble. With this the easy money flowing in response to the bursting of the in mind it is likely a new asset bubble is forming right now. US housing/credit bubble will have set the seen for the next With another huge round of liquidity about to hit markets on global asset bubble. Late last year ago there was much talk the back of global reflation Mark II, this is virtually of a bubble forming on the back of easy monetary policy in inevitable. But where will it be? the US flowing into Asia and some were arguing the US needed to tighten to head it off. Just as well it didn’t or else Recent bubbles the US economy would be in even worse shape. In fact, There is a long history of asset bubbles forming from the with growth in developed countries now slowing below ashes of the last bubble. Looking at the last two decades: levels necessary to stop unemployment from rising, further the collapse of the Japanese asset bubble in the early monetary easing is now on the way. The US Fed is talking 1990s and associated easing in Japanese monetary about another round of quantitative easing, or using printed conditions set the scene for the Asian equity bubble into money to buy government bonds. Japan is already doing the mid-1990s; the same - using printed money to buy US dollars and the burst of which in 1997-98 led to a bout of easy Japanese bonds and private securities. The Bank of money in the US and elsewhere and helped inflate the England is considering more quantitative easing. While tech bubble of 1999-early 2000; Europe is resisting, this is unlikely to continue next year as which then burst resulting in another round of easy European growth will likely slow in response to fiscal monetary policy setting the scene for the US housing tightening and a stronger euro. This additional round of monetary easing will likely see Emerging market shares are still trading at a slight discount to global shares - no bubble here yet! more downwards pressure on the US dollar, Yen, British 25 pound and ultimately the euro, but will see upwards 23 Forward PE, times pressure on the emerging country currencies, gold and 21 19 Global shares commodity prices and commodity currencies such as the 17 Australian dollar.1 Despite the Reserve Bank of Australia’s 15 surprise decision to leave rates on hold this month, it has 13 signalled a clear intention to raise rates ahead unless the 11 9 economic outlook changes dramatically. As such, more Emerging market shares 7 upside in the $A seems likely, ultimately taking it through 5 parity against the $US. 90 92 94 96 98 00 02 04 06 08 10 To the extent countries maintain fixed currency pegs to the Source: Thomson Financial, AMP Capital Investors US (such as Hong Kong) or resist upward pressure in their Commodity prices – while commodity prices have currencies by buying US dollars or keeping their own surged over the last 18 months – in most cases they interest rates artificially low, they will be importing easy US are still below their 2008 highs. Gold is an obvious monetary policy and adding to the increase in global exception having gone to a new high in nominal terms, liquidity. and it may be further advanced into bubble territory. But The end result will be very easy global monetary conditions even it is still below its 1980 high if measured in today’s for some time to come. And – unless the US double dips dollars which would be $US2000 an ounce. back into recession, which is not our base case - this More to go - the real gold price is still well provides an ideal condition for the inflation of the next asset below its 1980 peak 2400 bubble. 2200 $US per ounce 2000 Gold price in Bubblexicon 1800 today's dollars 1600 Bubbles are normally thought to exist when a combination 1400 of conditions are present. These include easy money, a 1200 1000 displacement exciting popular interest in the asset, 800 overvaluation and speculators piling into the asset on the 600 400 expectation that past price gains will be repeated. 200 Nominal gold price 0 Prime bubble candidates 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 As the US has had a monopoly on asset bubbles over the Source: Global Financial Data, AMP Capital Investors last decade and given its debt problems, it’s unlikely it will Australian resources shares are also trading at a slight host the next major asset bubble. Similarly debt problems a price to earnings multiple discount compared to the in Japan and Europe suggest they won’t either. Rather rest of the Australian share market. potential candidates for the next bubble include: Emerging market shares – emerging countries are As an aside, many have claimed that developed market increasingly attracting investors’ attention having come sovereign bonds are a bubble following the collapse in through the global financial crisis in reasonably good yields over the last six months. Bond yields are well below shape with low debt levels and given the risks hanging long term sustainable levels. However, to the extent that over developed market shares – both of which have growth is normally sub-par after financial crises and that provided a favourable displacement in terms of investor bond investors are making some allowance for the risk of thinking towards assets in these countries. deflation in the US and the chance the Fed might keep the Gold and commodity prices – these are another cash rate near zero for several years they may not be as possibility given the commodity intensive nature of bubbly as feared. Japanese bond yields around 1% are a emerging country driven global growth and increasing case in point. This is not to say bonds offer great returns inflows into commodity funds. going forward – on current yields there are much better Resource shares are also a potential area for bubbles opportunities elsewhere. to develop on the back of high commodity prices. Conclusion But if the next bubble will be in one or all of these, they The surge in global liquidity now underway is likely to likely have further to run. provide further fuel to the next major asset bubble which is Emerging market shares are not overvalued and are in likely already in the process of forming. Potential fact trading on similar price to earnings ratios as candidates are gold and commodity prices, emerging developed country shares. Chinese shares are in fact markets and resources shares. But the absence of obvious trading on PEs well below longer term averages. In overvaluation suggests we are still in the foothills of the other words there is little evidence of a bubble yet. next bubble which likely has years to run, with plenty of opportunities for investors in these assets in the interim. Dr Shane Oliver 1 See “Global Reflation Mark II, gold and the Australian dollar”, Oliver’s Head of Investment Strategy and Chief Economist Insights, September 2010. 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