A debate is raging in the financial world. Are cheap money policies fuelling a bubble in asset prices or not?
I’m not sure what all the fuss is about. The answer’s obvious. Of course most asset prices are at, or heading for, bubble levels. Oil’s near $80 a barrel even although there are ship-loads of it just floating around, being stored at sea. Most stock markets are overpriced in historical terms. Bond yields are at record lows.
The real question for investors is – are any asset prices justified at current levels? And if so, which ones?
Cheap money policies are inflating asset prices around the world. This seems self-evident. For one thing, everything is going up. Stocks, bonds, gold, oil, base metals – it doesn’t matter. Assets that shouldn’t really be correlated are all heading up together.
Now that might just be a sign that no one knows what’s going on, so the big bets aren’t being placed on any single asset class. And judging from the wide range of diverse opinions I’m reading and hearing from fund managers, investment ‘gurus’ and other journalists, I’d say that’s probably a fair comment. But it’s also a clear sign that there’s too much money flowing into the financial system.
The clearest sign we’re in a bubble
Probably the best sign that we’re in a bubble is this: all the people who are saying that this isn’t a new bubble are the same ones who said that the credit crunch couldn’t happen. Take former member of the Federal Reserve board of governors, Frederic Mishkin. In a piece for the Financial Times this week, he argued that there probably isn’t a bubble, and even if there is, it isn’t dangerous enough to warrant the Fed tightening monetary policy to prevent it from growing any further.
It’s a variation on the same old drivel that got us into this mess in the first place. It’s hard to spot bubbles, he says: “asset-price bubbles… are hard to identify; after the fact is easy, but beforehand is not”. Mishkin also argues that if you tighten monetary policy to “restrain a bubble that does not materialise” then you get “much weaker economic growth than is warranted.” Piously, he adds: “Monetary policymakers, just like doctors, need to take a Hippocratic Oath to ‘do no harm.’”
This last comment gives an interesting insight into how central bankers think. If your idea of ‘doing no harm’ is to pump a patient full of adrenalin every time they catch a cold, then perhaps this metaphor makes sense. But of course, over-stimulating an economy is just as dangerous as under-stimulating it. And our experience of the past 25 years of serial bubble-blowing should surely have taught us that by now.
In any case, as Edward Chancellor of GMO points out in a letter to the FT this morning, Mishkin’s words are worth taking with a big pinch of salt. Back in January 2007, he also said that falling home prices were “unlikely to produce financial instability.”
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So on the one hand, the bubble blowers are still pleading ignorance. On the other side of the debate, you have intelligent successful investors such as Marc Faber of the Gloom, Boom and Doom report, who argues that: “when interest rates are near zero, and when central banks print money, the existing and newly created liquidity will flow somewhere. And given the enormous excess capacities that plague the manufacturing sector, these excessive liquidities won’t flow into investments in plant and equipment and translate into the employment of more workers, but will flow into asset markets and boost their prices.”
What this means for investors
What does all this mean for you as an investor? First things first, it’s hard to trust markets when their health is based primarily on the actions of central banks and governments. That’s one reason why we prefer to keep an eye on the fundamentals rather than taking punts on how big the next phase of quantitative easing might be.
So as we keep saying, defensive stocks, paying decent dividends, still look good. They might not rocket like more speculative plays, but you also don’t have to keep one eye on the Bank of England all the time. On top of that, you get a decent income. And better yet, if stock prices keep rising, you’ll get the benefit from that too.
Emerging and Asian markets are also worth having exposure to. My colleague Cris Sholto Heaton writes about these regularly in his weekly free email ‘MoneyWeek Asia’ (if haven’t done so already, sign up to MoneyWeek Asia here). For one thing, these economies look healthier in the long run than over-indebted Western ones. And for another, these markets are likely to attract a lot more of that cheap money flowing around the world just looking for a home.
Gold’s bull run is set to continue
And then of course, there’s gold. It’s at a record high (in US dollar terms at least) and so people are getting worried that it’s in a bubble. But gold is probably among the few assets whose current valuation makes perfect sense. It’s the closest thing we have to a fixed point in the financial system. If you imagine that gold, over the very long term (and I really am talking about decades and centuries here), essentially maintains its purchasing power, then you can use it as a barometer of how over or undervalued everything else is. Its price is soaring because by comparison, the value and credibility of paper money is in sharp decline.
And until central banks decide that paper money is worth defending, gold’s bull run is set to continue. Our regular commodities correspondent Dominic Frisby talks more about gold (and throws in some mining tips) in this week’s issue of MoneyWeek magazine, out on Friday (if you’re not already a subscriber, you can subscribe to MoneyWeek magazine).
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