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Another Stock Bubble Underway?
Charlie Fell of the Irish Times reports, Bernanke encouraging another stock price bubble:
US
stock prices continued their upward march in January and have now
jumped almost 25 per cent since the chairman of the Federal Reserve, Ben
Bernanke, first hinted last autumn that the central bank intended to
introduce a further round of quantitative easing.
The
Fed’s deliberate attempt to drive stock prices higher and generate
second-round effects on economic activity has seen valuation multiples
rise to nosebleed levels once again and it is becoming increasingly
clear that another dangerous asset bubble may well be in progress.
Could
investors really be foolish enough to push stock prices back into
bubble territory for the third time in little more than a decade?
Unfortunately, the evidence from experimental economics suggests as
much.
Nobel laureate Prof Vernon Smith is a pioneer of
experimental economics and has conducted numerous controlled experiments
to explore the dynamics of asset markets.
A ground-breaking
paper co-authored by Smith and published in 1988 constructed an
experimental asset market in which the participants trade a fictional
asset with a finite life of 15 periods. Each subject is endowed with
cash and shares of the asset and is free to post bid and ask prices to
buy and sell shares at will. Each share of the fictional asset pays a
random dividend at the end of each trading period and the asset’s
terminal value following the last dividend payment is zero.
The
subjects are instructed that there are four equally probable dividend
outcomes at the end of each period and are given the payouts – (0, 8,
28 and 60 cents) that correspond to each outcome. Determining the
security’s fundamental value is a relatively simple task given the
information provided.
Since traders in the experimental asset
market have all the information necessary to calculate the asset’s
intrinsic value, common sense would suggest that formation of a bubble
is virtually impossible, yet this is exactly what happens. The
inexperienced traders initially price the asset at a discount of as
much as 80 per cent to its fundamental value.
By the fifth
period, the asset becomes overpriced and a bubble is created by the
10th period with the asset often reaching three to four times its
fundamental value. Sometimes the price even exceeds the maximum
possible value the asset could return in dividends – where the highest
dividend of 60 cents is paid at the end of each trading period.
Needless
to say, the asset’s price collapses towards zero as the experiment
enters its final stages. The substantial deviation of transaction prices
from fundamental value alongside the large turnover – often as much as
six times the outstanding stock of shares over the 15-period
experiment – runs contrary to the predictions of economic theory.
The
surprising result is often explained by the speculative motive whereby
rational traders judge the behaviour of other participants to be
irrational, and knowingly purchase overpriced assets in the hope of
offloading them to irrational subjects at a higher price – the so-called
Greater Fools. The presence of irrational traders is not necessary to
produce a bubble so long as some traders believe others’ behaviour to
be irrational.
However, this conclusion is undermined by recent
work conducted by Vivian Lee and others, which controls for the
speculative motive and limits the role of each subject to either buyer
or seller, completely eliminating the ability of any agent to buy for
the purpose of resale. Prices still deviate substantially from
fundamental value on heavy trading volume and the pattern of prices
exhibit the same boom- and-bust features originally reported by Smith.
It seems inexperienced traders behave irrationally after all.
Smith
reveals that the only way to reliably eliminate price bubbles in
experimental asset markets is through increased experience in the same
environment. Smith invites the original subjects to return for a second
experiment with the same parameters as before, and contrary to what
might be expected, a further bubble develops, although its duration and
magnitude are less than observed in the first experiment.
The
bubble gathers momentum far more quickly than in the first experiment
with prices typically moving above fundamental value in the second
period and reaches its climax by the seventh period with the security
peaking at roughly twice its fundamental value. Importantly however,
upon returning for a third experiment, “trading departs little from
fundamental value”.
The evidence from experimental markets would
appear to suggest that a third bubble is virtually impossible to
produce, but in a 2008 paper entitled Thar she Blows? Can Bubbles Be
Rekindled With Experienced Subjects?, which Smith co-authored with
Reshmaan Hussam and David Porter, the authors demonstrate that it is
possible to precipitate a further bubble under certain circumstances.
The
experiment is constructed in a similar manner to the previous two, but
for an increase in both the variability of dividend payoffs and
initial cash levels. There are now five equally probable dividend
outcomes at the end of each period – (0, 1, 8, 28 and 98 cents); the
amount of stock distributed to subjects is halved and their initial
cash level is doubled.
The greater liquidity combined with the
increased variability of payoffs results in a third bubble that peaks
in the fourth period, earlier than the first two experiments, and at a
75 per cent premium to intrinsic value.
The
conditions in today’s market appear to resemble Smith’s third
experimental market as the variability of outcomes following the Great
Recession remains wide, while near zero interest rates combined with
quantitative easing has allowed stock prices to trade at above-average
valuations once again.
The evidence from experimental asset markets suggests the Federal Reserve has given birth to another bubble in stock prices.
There are plenty of signs that another stock market bubble is underway.
Some sectors are already experiencing parabolic moves. JDS Uniphase's
(JDSU) huge December quarter triggered an optical stock frenzy
on Friday. You're now seeing stocks pop 20-30% in a day as they beat
Street estimates, much like they used to during the tech bubble.
Don't
get me wrong, tech is cyclical and you can make a macro and micro case
as to why technology shares were due for a big bounce, especially after the 2008 deleveraging crisis,
and why the uptrend will continue. But the moves I'm seeing now aren't
just about fundamentals. With trillions in assets under management,
there are plenty of momentum chasing hedge funds and mutual funds that
are piling into some stocks and sectors looking to profit off the next
big trend, fearing underperformance and being left behind.
This
is where things get extremely tricky. Why? Because there is so much
liquidity in the financial system right now that stocks can take off in a
huge way. You're going to see a speculative frenzy in various sectors,
not just tech. John Maynard Keynes once remarked: "markets can stay
irrational longer than you can stay solvent". We've seen this all
before, we know how it's going to end but we don't know how long it
will last. It can easily gain momentum as every pullback is bought hard
and shares keep forging ahead, making new highs. And don't be surprised
if it lasts a lot longer than the skeptics forecast. Hedge funds,
mutual funds, big banks' prop desks, sovereign wealth funds, underfunded
pension funds, endowment funds, insurance companies, and retail
investors are all gunning for yield.
But stock bubbles are a double-edged sword for pensions. Given that
equities are the most important asset class, pensions benefit on the way
up but are also exposed on the way down. After 2008, pensions can't
absorb another 20% or 30% haircut. Most mature pensions are underfunded
which means they have little room for error and have to protect against
downside risk. I spoke with two senior Canadian pension fund managers
last week. One of them told me liquidity risk remains his "top concern"
and another one told me multiples in public and private equities are
back "at pre-crisis levels". Both of them are concerned with the run-up
in stocks.
The 'Bernanke put'
continues to encourage speculative activity in all markets, but it's
the stock market that everyone is focused on because stock prices have a
huge impact on institutional and retail portfolios. My fear is that
another stock bubble is underway and despite lessons from the past, it
will last a lot longer than we think. Many portfolio managers will
succumb to performance anxiety and chase indexes higher, driving
multiples to new highs. In this environment, risk management is
critical. If another stock market bubble takes off, mature pension plans
have to focus on liquidity risk and be prepared to sacrifice upside
gains for downside protection.
»
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Is Robo not being junked a sign of a top? :)
The fish can't even see the parallels to early 2008 with big oil, big food, big gold etc.
Then one fateful August night it all started as it will again very shortly, I'd say April this time, even if it is August who give a shit. Cash and my precious are just fine thanks.
Leo is right, it just btohers you that you didn't write it first.
But then, again, who'd we sell our shares to if we didn't have the fish
thanks
Invasion of the Leo snatchers
LOL
Leo relax - the fish are pulling your chain.
Well they'll cry when they get their mnargin call and we'll be on the other of the trade like we were in December 08 to March 09
Just keep buying stocks ya fish. Then, just like 2008, one beautiful Sunday night you'll get fucked over by a sovereign collapse like Lehman.
Come that Monday you'll push the panic button as your margin desk calls and cry that you didn't understand what leverage was.
No worries though, we'll be there for ya, I promise. Cause ya see, we love you fish.
Have a good one Leo, patience wins the race
Asset Bubble or just the New Normal due to devalued currencies?
Dr Jekyll and Mr Kolivakis
The bigger (bubble) they are, the harder they fall!
Since we all know this bubble is fed by QE2, there is a perception that its all "printed prosperity" and that its weighted toward moral hazard. When everyone begins to see the collapse, it will be a mass stampede for the exits in order to take theirr money and run. A liquidity crisis will be a certainty when that happens.
haha.
Hope you are prepared to die young.
I am
It is the result of me blowing my brains out with hard drugs via a wacky phycirist playing God with my medication.
The FED= Market... were fucked!
Once you start blowing bubbles it is so much fun, you just don't want to stop.
I'm in for the ride.....just stay with oil, metals, grains and some manufacturing until Uncle Ben raises the rates...ya' just don't get in the way of a freight train.
Ummm, no shit and you were too busy looking at pensions as if they were a sacred trust.
A ton of military will be coming home whenever the Empire decides to close down.
Lots of angry people with guns... good thing the Constitution still works...until it doesn't.
Thankfully Roger Good and Colin Powell showed the American people the Declaration of Independence
Although, that document is not which governs
don't forget that most of 'em have wives at home that can already shoot. prolly better than average.
I pulled out of stocks this past Friday. Not like I had a lot left in it, I just don't care anymore. Let it soar to hyper-parabolic inter-dimensional fiat planes of non-existence and then plunge into the econo-abyss of central banking's Tartarus.
pulled out of stocks and into C(R)cASH?
Yes cash to invest in hookers and blow!
Pop like a giant baloon in ___ years.
Yen is getting too damn expensive.
Damn you 200% Debt-to-GDP.
Packers won!
Ben was wrong
Desperate people doing desperate things. Carnival barker Bernanke herds them into the big tent...
But this time is different.
1) because everybody knows it's coming
2) just nobody knows when
Party on Garth!
Yep, "the roaring 20s" stock market bubbles all over again. Different bankster faces, same bankster tactics. And we know how it ended.
You got it right Leo. There is no "fence" just a liquidity train that all must be on (if you are foolish enough to be participating in these fraudulent markets). Only two things will end this 1) they pull liquidity (not gonna happen) or 2) there is an exogenous event (global default) that "they" can not control. Hell, then the autobuybots still have to turn on each other. Bottom line is this will all end in a horrific manner that will devastate all.
Next target on SPX may be 1360. If it keeps going up, how the market behaves when it gets there will tell us a lot.
Something's wrong here, no one has attacked you or junked you.
heh, i saw another 'unjunked' robo-post a few days back too.
maybe the clan is gonna let him back in.
maybe there is hope for the world, after all.
long-live-the-robo
Robo is one of us. He will return to the dark side of the force.
Robo and now Leo coming around.
I am not opposed to either of them
trying to trade the Bernank scam......
so long as they are willing to concede
it is not a bull market (as we have known
them in the past) but a manipulated
fed-induced monstrosity.
+ that's where i am, too. it may look bullish, but these guys clearly know the cause.
i suppose the question is whether or not the cause matters... (a tree in the woods, etc.)
wouldnt this be considered a major bull move in a bear market?, and as such until the bear reappears, some might not know to even look for the bear.
7x3 = 10 lol a machine
I give it a month.
So, what's next? Crashing China? Crashing US-Stock market? The Euro finished? Food riots? A war between Cambodia and Thailand? Australia? Turkey? Finnland? (all of these seem to have property bubbles (Finnland: heck, even the finance minister talks about it now - and if you hear a politician about such a thing, you better run!)
And what about that? Military Standoff between China and the USA?
http://www.telegraph.co.uk/news/worldnews/wikileaks/8299495/WikiLeaks-US...
Uh-Oh! Where is my tin foil hat? I am in my 20's - I mean, gimme a break! I don't want to end as a Panzerfahrer.
Trade early, trade often.
- the Bernank
http://www.financialchat.com/blogs/commercial-paper-vs-baltic-dry-index-...
Here's the latest market prediction from the legendary Jeremy Grantham of GMO.
Jeremy still puts fair value on the S&P 500 at ~900--a healthy 30% below today's level of ~1300. This assessment is similar to that of many other value-conscious investors, including John Hussman and Robert Shiller.
But this is "Year 3 of the Presidential Cycle," Jeremy says. And, historically, "Year 3" has been good to stocks because the government does everything it can to help get itself re-elected, including flooding the economy with cheap money.
And interest rates are still fixed at near-zero, Jeremy notes. And, usually, emerging bubbles don't burst until rates are rising.
So enjoy the ride until October, says Jeremy. Then sell everything and head for the bomb shelter.
So, where are we now? Although “quality” stocks are very cheap and small caps are very expensive (as are lower quality companies), we are in Year 3 of the Presidential Cycle, when risk – particularly high volatility, but including all of its risky cousins – typically does well and quality does poorly. Not exactly what we need! The mitigating feature once again is an extreme value discrepancy in our favor, but this never matters less than it does in a Year 3.
This is the age-old value manager’s dilemma: we can more or less depend on quality winning over several years, but it may well underperform for a few more quarters. We have always felt we should lean more heavily on the longer-term higher con?dence.
As a simple rule, the market will tend to rise as long as short rates are kept low. This seems likely to be the case for eight more months and, therefore, we have to be prepared for the market to rise and to have a risky bias. As such, we have been looking at the previous equity bubbles for, if the S&P rises to 1500, it would of?cially be the latest in the series of true bubbles. All of the famous bubbles broke, but only after short rates had started to rise, sometimes for quite a while. We have only found a couple of unimportant two-sigma 40-year bubbles that broke in the midst of declining rates, and that was nearly 50 years ago.
The very famous, very large bubbles also often give another type of warning. Probably knowing they are dancing close to the cliff and yet reluctant to stop, late in bubbles investors often migrate to safer stocks, and risky stocks betray their high betas by underperforming. We can get into the details another time, but suf?ce it to say that there are usually warnings, sometimes several, before a bubble breaks.
Overvaluation must be present to de?ne a bubble, but it is not a useful warning in and of itself. I fear that rising resource prices could cause serious in?ation in some emerging countries this year. In theory, this could stop the progress of the bubble that is forming in U.S. equities. In practice, it is unlikely to stop our market until our rates have at least started to rise. Given the whiffs of de?ation still lingering from lost asset values, the continued weak housing market, weak employment, and very contained labor costs, an in?ationary scare in the U.S. seems a ways off.
Read more: http://www.businessinsider.com/jeremy-grantham-stocks-will-go-up-until-october-and-then-theyll-crash-2011-2#ixzz1DELMEGblBy preaching the truth you anger the Borgia's.
According to Jimmy Rogers, he would not buy any stocks here and his view on Commodities is spot on (no pun intended) as the Soft futures prices are all at contract highs based on his simple reason that there are less and less farmers in the world..and thus a decreasing supply of soft commodities (rice, soybeans, wheat, etc) ... Make sense to me.
http://chart.ly/4kmwlir Futures charts slideshow..
If you were able to become wealthy from futures; this would have been obvious six months ago; which it was; also obvious was the tremendous double top in the thirty year bond contract which has now paid off over 22.000$ per contract; more to come; there is no day trading. position trading produces as much money as you want.
One of the primary purposes of the QE2 is for the Fed to do a stealth bailout of state/local defined benefit plans that are underfunded by $2-3 Trillion. This bailout is going to be paid by all Americans (and many others) paying via higher inflation, and some developed countries paying with blood from civil conflict caused by higher food and fuel prices.
Bernanke knows exactly what he is doing and it is the least worst alternative, even though it represents a cynical and dishonsest abandonment of any pretense that the United States is a free market capitalist economy.
Welcome to communism, American-style.
"My fear is that another stock bubble is underway and despite lessons from the past, it will last a lot longer than we think". Good to know some bears are getting over the 2008 black swan event.
Don't forget that FED needs excuse for next round of QE, so befor the july s&p could be at 1200. And my second point: look at rising long term interest rates - probably its gonna cause even deeper falling of housing prices. So, how could stocks rally while we're watching anther 10% dip in housing, where BTFD just doesn't occur?
where's leo? what happened to leo? what did you do to leo?
Yes, bubbles are all we have left as investment vehicles...
you're "nuts" not to join this rally you said but today it's "pushing to bubble (ie. nuts) territory"... have you a split personality Mr Kolivakis or just got splinters in your arse jumping onto that fence you're now sitting on?? ....make your friggin mind up peanut brain
What don't you unnderstand? I saw this coming a long time ago and have steadfastly warned all you big bad bears on ZH that we're heading higher. Go ahead, short this market, but don't come crying to me after. I wouldn't dare short a market in the early phases of a bubble....way too risky. Watch the pullbacks and how hard they're being bought.
i dunno mr. K,
after following you for a while, you're pretty hard to pin down - at least as hard as this market is, so i give you plenty of space.
to be sure, you're willing to suffer that ugly grey that the black/whiters of ZH (myself included) hate so much.
so long as they keep that BB press running, you've been right.
and in the reality of the situation, that's f--king irritating.hard not to get pissy with the messenger.
the pix you used to post did help a little bit, tho' :^)
He has an enemy within ;-)
Oh, so now that the bulls realize they are being lead by their nose rings, they are now concerned where they are going -- to greener pastures or the slaughterhouse?
Actually, yes; it's another bubble. There are no lessons from the past. The American Creature has an attention span, of five minutes. What's the next question , this one was awfully easy. This isn't the way I got 800 out of 800 years before the SAT was devalued to pump up the mental minorities.