One thing has been consistently lacking from this bull market – exuberance.
Stockmarkets – in the US, specifically, but in quite a few other places too – show many signs of being overvalued.
But, as Jeremy Grantham of GMO puts it: “The current market lacks most of the behavioural indicators of a true bubble”.
You don’t hear people bragging to each other about all the money they’ve made in stocks. There are few signs of the proper, full-blown excess you get at the top of the market.
But what if this apparent lack of exuberance is purely because the real bubble has been blown in what is traditionally the world’s most boring asset class?
Bond investors’ idea of exuberance
Bond investors are traditionally viewed as the “grown-ups” in the investment market.
Equity investors are wide-eyed optimists, always willing to believe the best about every company they invest in. They are trusting – gullible, even – blinded by the idea of the limitless riches they shall reap when the investment of their choice becomes a world-beating company.
Bond investors are different. They pore over balance sheets, spectacles perched disapprovingly on the ends of their noses. Bond investors typically know what their upside is – getting repaid in full alongside their interest payments. So it’s the downside they focus on.
This is one reason why I am not 100% convinced by the arguments that we can’t be in a bubble because no one looks excited enough about it.
It’s true that when equity investors get excited, they simply can’t hold it in. They will do any number of silly things and buy up any old nonsense, as if every new issue is their chance at a golden ticket. When equity investors get exuberant, you know all about it. It’s all fireworks and frenzied exhortations to join in.
But bond investors? Imagine a Holiday Inn at a service station off the M25, where by chance, the local accountancy firm has booked its Christmas do for the same evening as the local undertakers. Imagine the after-dinner disco. That’s about as exuberant as bond investors get. They’re excited, sure – but most people can’t really tell.
I am, of course, mostly joking. Bond investors can be as daft as the rest of us – look at the recent queues to buy negative-yielding or Argentinian debt, for example.
But I just wonder if those seeking exuberance in over-valued markets, and being reassured by its absence, are looking in the wrong place. US stocks (in particular) look overvalued, yes. But maybe this is just an “echo bubble” – a symptom of the far greater bubble in the bond market. Hence the lack of the usual sociological bubble indicators.
Partying like it’s still 1999
The FT’s Attracta Mooney has an interesting piece in the fund management section of the paper today, on bond bubbles and quantitative easing (QE).
Here’s a particularly eye-catching quote from JPMorgan’s Bob Michele, a veteran bond fund manager (in other words, someone who still remembers a time when interest rates weren’t hugging zero) who is feeling nervous about the end of QE.
“I am not an equity investor, but I can just imagine how equity investors felt in 1999, during the dotcom bubble.” That’s as good an acknowledgement of irrational exuberance as you’ll ever hear.
And bond funds have been popular this year. Apparently fixed-income funds have seen $355bn of new investment in the US in the first five months of this year, according to figures from Morningstar. That’s almost as much as went into the market for the whole of 2016.
This might seem odd. After all, the big concern for bond investors right now is that central banks have been printing money to buy big chunks of their market. Now central banks want to try to step back from doing that.
You can try to spin this in whatever way you want to. But at the end of the day, you’ve had a huge buyer in this market. That buyer has intimidated just about everyone else with its price insensitivity, its literally limitless potential pot of cash, and its political connections.
Now that buyer no longer plans to be in the market.
Trouble is, says Michele, you don’t know when that’s actually going to kick in. “As long as money is being printed and prices are going up, you want to be involved. But you also want to be able to get out quickly.”
I don’t know if Michele was consciously mimicking Chuck Prince’s infamous pre-financial crash quote about “dancing while the music is playing” here, but the fundamental catch – as Prince found out – with wanting to get out quickly is that everyone else wants to get out quickly too.
People talk about problems with bond liquidity a lot at the moment, but in a way, that’s not really the core of the issue. If you’re worried about liquidity, you’re worried that the mechanics of the market mean that you won’t be able to sell your asset at a time of your choosing without moving the price against you.
But the real issue is the same problem you see in any post-bubble crash: once everyone wakes up to the idea that an asset is overvalued, nobody wants to own it anymore. So it’s not really about anything mechanical (although those considerations could exacerbate any crash). It’s really just about reality hitting home and everyone trying to sell at the same time.
These movements have momentum behind them. That’s why prices crash. When something falls from being clearly overvalued, it has to get to a point of being clearly undervalued before enough people are willing to buy back in to arrest the fall.
That’s why I struggle with the idea that any adjustment will be slow and steady and smooth. It may take a while to reach the tipping point, but the problem with markets is that they anticipate end-points and try to get there quickly.
If everyone wants to keep dancing right up until the last minute, then there will be a stampede for the exit door, no matter how much “forward guidance” or anything else the central banks provide.
Of course, the real question then is: how will the central banks react? That’s a topic for another day.