The bubble we have to have…
Over the course of the last month or so we have been witnessing a coalescing of words, sentiment shifts and policy pronouncements that suggest a bubble is about to be engineered by central banks and governments. The idea that we are in a bubble is thus potentially extremely premature. I am personally becoming convinced that, notwithstanding a few bumps along the way, we may see the inflating of a massive stock market rally that may run hard until 2016. The US credit cycle appears to be only mid way through its typical 5-8 years and the likely Fed heir Janet Yellen is making all sorts of pronouncements suggesting the adjective ‘doveish’ used to describe her is an understatement.
A. Last week I wrote: (you can read the whole piece again here)
“In Australia we don’t have a bubble in stocks or property yet, but we do have a couple of the key ingredients that if left unchecked could help fuel a bubble.
As we are on the subject of stocks and bubbles, it’s worth adding a postscript [about] the deep dark corners of the US Federal Reserve.
One of the conversations occurring in the halls of global central banks — but not being reported in the Australian press — is whether the Fed is about to embark on a ‘regime change’ by which I mean a very serious shift in policy.
When European Central Bank President Mario Draghi infamously pronounced – in just seven words – that the central bank would do “whatever it takes to preserve the Euro”, he signalled a massive regime shift at the central bank. And it worked.
When Japanese Prime Minister Shinzō Abe replaced both the Governor and the two Deputy Governors of the Bank of Japan and committed to setting ambitious targets for inflation by engaging in quantitative easing on a massive scale, he signalled to the world and its officials that to get something done, you really need to ‘move the dial’.
The US is looking at this in the context of a study which found that since January 2009 the New York Stock Exchange rose every week the Fed bought bonds and fell every week it didn’t.
The idea of fuelling a bubble may be gaining momentum.
We all know that the US economist Janet Yellen is taking the Chair at the Fed, and she has said that targeting inflation will play second fiddle to ensuring healthy employment. And the US central bank is widely regarded as having been unsuccessful in its policy settings as they relate to unemployment.
Christina Romer, who was head of Obama’s Council of Economic Advisers from January 2009 to September 2010, and a worldwide expert on the Great Depression, may replace Yellen as Vice Chair of the US Federal Reserve. Christina Romer aligns with Yellen in that she forcefully supports the idea that withdrawing stimuli too early threatens a 1937-type economic reversion, and she believes that economic growth can be improved by changes in expectations on growth, and that if the Fed turns its focus to targeting nominal GDP, it can achieve its aim.
In a speech entitled Monetary Policy in the Post-Crisis World: Lessons Learned and Strategies for the Future that she gave on 25 October 2013, Christina Romer said:
“A final way beliefs may be important involves expectations of growth. People’s expectations about the future health of the economy have a powerful impact on their behavior today … If a central bank through its statements and actions can cause expectations of stronger growth, that can be a powerful tonic for the economy … for policymakers to really move the dial on expectations and push them firmly in the direction they want them to go — it takes a regime shift. Smaller, more nuanced moves are easily missed or misinterpreted by people in the economy.
“Back in 2011, a number of economists, including me, argued that the Federal Reserve ought to adopt a new operating procedure for monetary policy: a target for the path of nominal GDP … Switching to this new target would have some important benefits. In the near term, it would be a regime shift. It would unquestionably shake up expectations. Since we are currently very far below a nominal GDP path based on normal growth and inflation from before the crisis, it would likely raise expectations of growth, and so help spur faster recovery …
“Today, I worry that guilt over letting asset prices reach the stratosphere in 2006 and 2007 has made some policymakers irrationally afraid of bubbles. As a result, they focus on the slim chance that another bubble may be brewing rather than on the problems we know we face — like slow recovery, falling inflation, and hesitancy on the part of firms to borrow and invest.”
As I mentioned at the beginning of this article, we are not in a bubble … not yet, anyway.
B. This week: Janet Yellen during her Senate confirmation hearings last week echoed those famous seven words of Mario Draghi when she said, “I consider it imperative that we do what we can to promote a very strong recovery.” Given the US Fed has shown little monetary policy restraint since the GFC began, it’s hard to overstate her words.
Some analysts suggest the word ‘imperative’ implies a sense of urgency that we have not seen from the Fed in some time and which could be “a prelude to more aggressive actions in its attempt to stimulate job creation and a more robust economy.”
While everyone is worrying about tapering, I reckon we might be better positioned if we are worried about the opposite – a Bubble We Have to Have.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Richard Houston
:
Given what you have said what effect will it have on our dollar?
Will it go down to 0.80c or even lower? Could the bubble be good for Australia?
Roger Montgomery
:
A falling dollar would be great for our competitiveness!
Jason Jensen
:
Roger, has your view changed?
Correct me if I’m wrong, but a few months ago you were concerned that the market was overpriced and fundamentals didn’t support many current share prices.
I’d have to agree that this market can go much higher, but based more on heard mentality and artificial influences. I’m concerned we will repeat the pattern and possibly end in another financial crisis.
I know markets are irrational, but I’m wondering if you think this one is unusual? One part of the market, financials and healthcare at all time record highs, and other parts near or below GFC levels?
There seems to be extreme bullishness in the face of average economic data and company earnings.
Lastly, do you have an opinion on FGE and it’s profit downgrade?
Roger Montgomery
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Hi Jason,
I don’t think we are in disagreement; the market is expensive and the market could go a lot higher. if it goes a lot higher, it will eventually come down a lot harder. I don’t think the current situation is unusual at all – it represents a normal point that we see in every cycle for the broader market and for each sub-industry. Regarding Forge, we aren’t confident that the business will survive but it will depend on whether the pipeline of work remains (much of it dependent on Roy Hill) and whether its ability to win new work is affected by any possible perceived change to its reputation.
Richard Houston
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Hi Roger,
How long can QE go on for before US interest on its debt becomes a self fullfilling nightmare and crashes the market?
Roger Montgomery
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For as long as the rest of the world believes they are the lowest risk borrower Richard.
Gokhan Kaya
:
Agreed Roger.
Do you think Shiller P/E (http://www.gurufocus.com/shiller-PE.php) or Total Market Cap / GDP (http://www.gurufocus.com/stock-market-valuations.php) would be of any help in identifying a bubble?
Roger Montgomery
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Sure.
Kelvin Ng
:
Hi Roger, Stan Druckenmiller also thinks the stock market will continue to go up (among other interesting comments):
http://www.bloomberg.com/video/druckenmiller-cash-flow-is-company-truth-teller-MjZ8apeIRZeHLMKtfmigeg.html
Kelvin
Roger Montgomery
:
ENjoyed it. Interesting response to question about having the opposite view to Buffett on IBM.
Jim Hasn
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Hi Roger
The other problem is all the Fed members giving their spin on the “taper”. Sir John Templeton’s quote on bull markets i.e. born in pessimism, grow on scepticism, mature on optimism and die in euphoria, is looking a certainty here the way Yellen and Romer are talking. And we are only into the scepticism phase.
Roger Montgomery
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Great to hear from you Jim. Thanks for those comments; I think you and Sir JT are absolutely correct.
Joe Rich
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Roger – if stock prices continue to rise without being supported by rising fundamentals (i.e. earnings), surely this will be a huge negative for investors?
With central banks creating an environment where cash and fixed interest yields are far too low to attract any investment, more and more people will get sucked into investing into a market at prices above intrinsic values – thus sowing the seeds of future capital loss.
At the same time, I’m curious as to how banks will be able to lend more (to businesses to spur job growth – i.e. the stated aim of central bank policy), when savings will inevitably shrink due to a flight to riskier asset classes (e.g. real estate, equities)…
Roger Montgomery
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…it simply depends on what the banks decide is acceptable collateral Joe.
Hiten Ravani
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The idea is when stock prices rise it creates sense of wealth creation for business/companies. This leads to business using its increased market cap to go shopping for mergers/acquisitions and/or new business ventures. They would borrow money from the banks. New business ventures would create jobs.
The same idea is behind having ultra low interest rates. The central banks wants small/medium/large businesses to borrow money and invest/grow their businesses and thereby hire more people.
The ultimate goal of central banks and government is to have maximum people in the workforce. This means lower unemployment rate, low/no public unrest, more taxpayers, greater economic activity (more people working means more people being able to afford and spend money on materialistic consumerism). Good for businesses/stockmarket.
Everyone is happy. The only price to pay is rich keep getting richer as they invest in assets. I think governments and central banks are happy to pay this price in return for the above.
Roger Montgomery
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Thank Hiten,
Thus far the “ultimate goal of central banks” has been to keep a lid on inflation.
Hiten Ravani
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Yes..but I reckon the US central bank would love to see some inflation in US right now. So would Japan
John Stanning
:
It is hardly surprising we are not in bubble territory yet, when according to the Wall Street Journal,reporting the BlackRock Global Investors pulse survey; many investors still shun risk 5 years on with 48% still on the sidelines in cash.Not only have we seen major buybacks in a large number of US stocks(fewer shares available) but increased profitability driving the Dow and S& P 500 to new highs.Where is the euphoria like 2000 or 2007? not till sentiment catches up will we be in bubble territory!
Roger Montgomery
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Indeed John.
Kelvin Ng
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Hi Roger, I agree.
With this talk about negative rates coming from the ECB and Yellen at the helm of the Fed, its a TINA market – “there is no alternative”. Where are you going to put your money – cash? bonds?
Kelvin