An utterly miserable email arrives from Britain’s grizzliest bear, Société Générale strategist Albert Edwards. Here we go again, he says. We are “getting into the eye of a financial bubble”.
He knows this largely because he “has little comprehension of what is going on any more,” something he is pretty convinced is not “solely a reflection of his own stupidity”.
The signs of this bubble? There is the London housing market, a frenzy which isn’t really about Asian buyers looking for a safe haven, but about “excessively loose monetary policy and light-touch regulation.” There is even worry about a German house price boom.
There is China, where the authorities appear to have actually “lost control” of house prices. There is the US equity market, where the majority of stocks are far too expensive – the median price to sales ratio is at a record high and the cyclically-adjusted price/earnings ratio or Cape is – at 24 times – warning us all to leave well alone.
The message is there in the numbers, says Edwards, but just as was the case in 2007, “no one is listening”. Instead, the bulls in London are pushing asking prices for property (note that I say asking, not sale prices) up 10% in a month and the bulls in the US are pushing the stock market to new highs day after day.
I think Edwards is right. There are asset bubbles all over the place, some old (London) and some new (I’m coming to this). But I don’t think fund managers are as unaware of this as he does. They just don’t have the career courage to sit out the bubble in the way that he thinks they should.
What they have been doing instead – until recently at least – is trying to stay in the bubble, but to buy protection by holding the stocks that they think will get hurt least in the next bust. That means blue-chips, defensives, multinationals, companies that have some control over their own destinies or, best of all, some combination of the lot.
The idea that we must pay a premium for consistency, for cash generation and for income has been deeply ingrained in us since the crisis. Have a go at finding someone who disagrees. It won’t be easy.
But is there a bubble here too? Last year, I pointed out that a lot of the companies that various investors fit into the categories above are really rather more risky than you might think.
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I don’t need to say much about utilities, but it is clear that if you sell something considered a necessity or a public good in a time of austerity and political grandstanding, your shares should be trading at discount, not a premium.
The same might be said for tobacco shares, another standby of the managers holding defensive income portfolios. As a note from Daniel Leaf at Saracen recently pointed out: “from plain packaging to banning retail displays to horrific visual health warnings, governments have been accelerating their efforts to deter smokers from their addiction”.
That’s a structural threat, something the price of the shares should reflect. Instead, they are now valued at similar levels to the global pharmaceutical companies – which at least can lay claim to having some acceptable products.
Then there is the problem of the cash.
I have said before that the risk in many of the world’s bigger blue-chips is identical to their attraction: they have lots of money, money governments want for themselves. Hello margin-killing windfall taxes of the kind proposed by Sir John Major this week, anti-tax avoidance campaigns and so on.
At the same time, the interest rates that have allowed any reasonable-quality company to borrow at amazingly low prices must have had their day, and anyone who believes even a little bit in mean reversion must worry about corporate profits too. S&P 500 profits hit another all-time high in the second quarter of this year and there are expectations of the same again in the third and fourth quarter.
Margins are also still knocking around record highs. All this would be fine if the risks were reflected in the prices of the big, seemingly reliable companies everyone loves. But they aren’t.
Most of the companies you would think of as fitting the safe-and-steady bill trade on valuations well above their long-term averages.
Run your mind, if you can, through the stages of a bull market. First, very few people think things can get better. Then, most people believe things are improving and finally everyone thinks that things will get better forever.
The last bit is the bubble – the melt-up, the blow-off, whatever you like to call it. We are probably getting near to at least the beginning of this bit. How long will it last and when will it end? Who knows?!
Recent experience tells us that bubbles can last for years and have several exciting melt-ups before they implode. We can also continue to expect markets to be supported by the cash pouring in from the US and Japanese quantitative-easing programmes.
The money has to go somewhere, and it is perfectly easy for the bulls to think that asset prices are rising because the world is all but fixed and they are too cheap, rather than because they are in the path of a liquidity tsunami.
So, while the sensible, price-sensitive and long term might feel inclined to look beyond the consensus, the gamblers among us might like to ride the melt-up – buy more blue-chips, a few two-bedroom London flats and a basket of iffy Chinese tech stocks – and hope to get out in time. This occasionally works too.
• This article was first published in the Financial Times.
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