O Bubble, Bubble, wherefore art thou Bubble?
Deny thy consequences and refuse thy name.
![Picture](https://www.tamim.com.au/uploads/6/6/0/7/66077715/published/sid1-sq.jpg?1617844010)
Author: Sid Ruttala
Let me elaborate. It is true that equity market valuations have hit all-time highs and asset valuations continue to skyrocket, but against what? That is where the question becomes more nuanced. Since the beginning of the covid pandemic, money supply indicators, including broad money, have shown double digit growth, 20% USD, 11% AUD, 10% in the Yen and the numbers continue across most of the world.
So that is the first point, for the much older investors, the markets may not be as irrational as they may appear. Coming back to the RBA and IMF. There were two things that the board addressed and the IMF corroborated. The first, you get the feeling that they feel asset valuations are a cause of concern though the Governor didn’t go that far as to explicitly state it (and neither should he) but even if this were the case that should not necessitate a normalisation of rates. Rates being the most important factor when it comes to asset prices.
Even pertaining to equity markets, take a look at the below graph. It showcases that US investors had borrowed close to $814bn USD against their portfolios as of late February (the biggest monthly increase since 2007).
For a further walk down history lane, it was precisely these requirements apart from the Fed Funds Rate that enabled one of the largest expansions in the US real estate market pre-GFC. This time we are likely to see the opposite happen. Lending standards and capital requirements are likely to see tightening as the economy recovers with the implicit hope of cooling off credit growth. From an allocation perspective, we are unlikely to see any changes to the headline cash rates globally. This however, despite what has been said, is not a choice but necessity. As we have elaborated upon previously, covid has brought about fiscal deficits across most of the western world that we have not seen since the World Wars and the case is similar across most emerging markets. Even slight increases in headline rates will have immense implications upon the debt-servicing requirements and consequent tax burden. To give you a context of the magnitude, the central bank balance sheets of the US, BoJ, RBA and ECB expanded more in the year 2020 than the five years following the GFC.
Stateside this will likely continue under the new administration, an additional $2tn earmarked already. At home, don’t forget an upcoming election down under. If the recent trends regarding longer-term yields are anything to go by, we are probably going to see most of the new spending and debt-issuance end up on central banks’ balance sheets given little appetite from alternative investors.
As for the question of a bubble? Maybe we are in one, but it is potentially the wrong question all together. The more apt question is, given the incentives for policy makers, government and the amount of liquidity that is driving this, what are the likely outcomes? Take the example of income inequality, one might then ask themselves the question, what does this mean for luxury goods? Or within property, what does this mean for high-end vs. low-end properties? If the cash rates stay low and regulatory tightening occurs on the lending side, what does this mean for my bank shares? This core part of so many Australian portfolios is an interesting one. Anecdotally, a home loan specialist at one of the big banks recently told one of our team that they have rarely been busier than in recent months. Many Aussies have taken advantage of the current situation to lock in low rates. What happens when the banks’ NIMs get squeezed further though? And their loan book growth if lending standards are tightened? This might not happen any time soon (maybe when those locked in rates roll off and become variable in five or so years though?) but it is definitely a consideration for many of Australia’s retiree population. The Australian retiree that has the vast majority of their wealth in a “diverse” selection of property and bank shares is placing a lot of faith in what is essentially one big bet. If the property market finally takes a dive, it will take the banks along for the ride. Given the Australian index’s reliance on and weighting toward the Big Banks, a dive from the property market (and the accompanying problems for the banks) could trigger a much broader sell off across Australian equities. This is perhaps the best argument for ensuring you are also diversifying into international equities.
From the fiscal side of the equation, if we are likely to see increased government spending, what might this mean for infrastructure? This has been one of the big thematics for our global equities manager Robert Swift for a number of years now, a theme kicked into overdrive by covid stimulus. Or what about the effect of direct stimulus upon consumer discretionary spending? A segment that our Australian equities manager Ron Shamgar has been very much on top of this past year.
So going back to the original questions, in this particular author’s humble opinion. Bubble? Possibly by historical standards but there is a little more nuance to this than first meets the eye. Irrational exuberance? No, when you consider the nuances mentioned above. Are we at the beginning of a bull market? Probably, might be a lame one though.