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…[A] bubble is the state of a market before the crash. It is a situation in which assets trade at a price
that is considerably higher than their intrinsic value…[and,] in my view…we’re currently in a bubble…The current S&P 500 P/E is at 25.09 (when the historical average is 15.61). [The question is,] “When will the market crash?” and [I see]…worrying signs that this could happen soon.
The comments above and below are excerpts from an article by Greed & Fear which may have been enhanced – edited ([ ]) and abridged (…) – by munKNEE.com (Your Key to Making Money!)
to provide you with a faster & easier read.
Today everybody knows there’s too much liquidity in the financial system that is being provided by Central Banks’ ultra-loose monetary policies through quantitative easing, asset purchase programs of sovereign bonds, corporate bonds and even equities and too low (virtually zero or even negative) interest rates for too long. As a consequence, we have bonds trading with negative yields, not only sovereign but also corporate bonds.
I have no doubt that in a few years, we’ll look back and say this was a nonsense and an obvious bubble. In fact, savers are paying borrowers to lend them their own money and they still have the risk of losing their principal. Another way to put it is that savers are paying a new wealth tax to the government or that bondholders are subsidizing the companies they lend money to.
Don’t be mistaken, however, to think that this bubble is limited to negative-yielding bonds. Instead, it is fueling very rich valuations across all asset classes. In fact, if the safest bonds have negative yields, high yield bonds also trade at historical low yields, while real estate and equity prices are pushed higher for comparison reasons (or absence of a better alternative).
Are we in a bubble today?
My view is yes, we’re in a bubble. I call it the Central Bank bubble or the ZIRP bubble (zero interest rate policy) or NIRP (negative interest rate policy) bubble…
- the current P/E is at 25.09 (when the historical average is 15.61), the Shiller P/E is at 26.93 (when the historical average is 16.69) and current price-to-sales is at 1.92 (when the available historical average is 1.48).
- For the S&P to trade at its historical average, it would need to correct between 23% and 38%, depending on the metric used…
- [Any] attempts to justify current equity valuations with the fact that the earnings yield is higher than the Treasury yield, or through the idea that equities offer a higher dividend yield than Treasuries, are…flawed.
When will the market crash?
The current asset prices are being fueled by the Fed’s (and other Central Banks’) ultra-loose monetary policy so normalization of monetary policy poses a big threat to current equity prices (as well as real estate, fixed income, commodity and all other asset classes).
In this regard, there are worrying signs that this could happen soon:
- the libor rose to 83 basis points over the summer, the highest since 2009 and surpassing the levels seen at the peak of the European sovereign debt crisis and it seems to have already incorporated a potential 25 basis point rate increase by the Fed.
- Furthermore, Government bond yields in Germany, Japan and the U.S. have been rising over the summer specially in the longer part of the curve.
In Summary
Few argue against the fact that asset valuations today are very expensive but many say that you should be in the game because this bubble can go on much longer than we think. They believe interest rates will stay “low for long” or “low forever” or “will get even lower” and that being in a bubble alone is not “actionable” enough. I disagree.
What other reason do you need to act? You have:
- eye-watering asset valuations,
- earnings declining for 5 consecutive quarters,
- the libor and government yields rising and
- the Central Bank’s speech changing as
- the inflation ticks up and
- the unemployment declines.
It is time to take profits, to increase your cash position or at least to buy some protection.
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