Alarm bells are ringing for economic fundamentalists such as Fathom Consulting.
Asset prices look increasingly out of step with fundamentals, and in some cases they look downright bubbly. And other geopolitical developments are similarly alarming. One might even describe them as…
Equity prices in developed economies, and specifically in the US, are more than one standard deviation higher than their long-run average in relation to nominal GDP.
The Nasdaq has again played its part, posting an even greater degree of fundamental overvaluation than the S&P 500. Its degree of overvaluation in relation to nominal GDP is now close to its dotcom bubble high.
Government bond prices across the developed world are at all-time highs. Bond prices have been increasing consistently since the 1980s, with a series of global shocks driving that move.
Total central bank assets across the developed world now stand at over $14 trillion, having increased by about $10 trillion since the recession.
Over the same period, the new issuance of government debt has increased dramatically right across the G5. All else the same, you would expect such an increase in government debt to result in higher government bond yields (lower prices).
However, short rates have fallen to the lower bound and QE has been introduced, mopping up almost all of the value of new issuance of government debt across the major developed economies. It is no surprise, therefore, that the price of government bonds has increased over the same period, by around 18%.
Is it possible for there to be a bubble in government bond prices in the world’s leading developed economies? Unlike other asset markets, there is no realistic question about the long-term risk attached to the underlying asset. Economies do not go out of business. However, they do default and, while a hard default is unlikely for these economies, a soft default via inflation and/or financial repression is not.
Bubbles in asset prices can arise, and can burst, without necessitating a complete collapse in the value of the underlying – in this case a hard default.
Put another way: is there any threshold for bond prices beyond which we would call a bubble? If such a threshold exists, we have surely passed it. The bubble emerges as follows: the major central banks entered the market for government bonds in 2009 and have bought $1 trillion a year since then. They were committed to buying no matter the price. In addition, there are other parties who are obliged by regulation to hold large quantities of government debt from the major developed economies.
For the remaining free agents in bond markets, the rational step is to buy, safe in the knowledge that, for the time being, there is always another buyer out there who will pay more. That implies we should be concerned about the impact of a reversal in QE – if we’re in a bubble, that could burst it.
Mutual Assured Destruction (MAD) was something we all hoped we had left behind in the 1980s. But now it is back. The only way we can sleep soundly in the current geopolitical environment is in the knowledge that possession of nuclear weapons will not result in Armageddon as long as the logic of MAD holds. No sane person would ever press the button. But, for MAD to work, all parties have to believe that every other party might press the button.
MAD fails if everyone is rational and is perceived as such. But it also fails if anyone is actually mad. At present, markets appear sanguine about the risks around North Korea (Equity investors are not worried about a US/China trade war): let us hope they are right.
This is genuinely uncharted territory: here be dragons!
Full article can be read here Fathom Consulting via Thomson Reuters
News and Commentary
Gold Prices (LBMA AM)
12 Oct: USD 1,294.45, GBP 977.96 & EUR 1,092.26 per ounce
11 Oct: USD 1,290.20, GBP 978.62 & EUR 1,091.90 per ounce
10 Oct: USD 1,289.60, GBP 977.77 & EUR 1,094.61 per ounce
09 Oct: USD 1,282.15, GBP 976.23 & EUR 1,092.01 per ounce
06 Oct: USD 1,268.20, GBP 970.43 & EUR 1,083.93 per ounce
05 Oct: USD 1,278.40, GBP 969.28 & EUR 1,086.51 per ounce
04 Oct: USD 1,275.55, GBP 960.87 & EUR 1,085.11 per ounce
Silver Prices (LBMA)
12 Oct: USD 17.20, GBP 13.06 & EUR 14.50 per ounce
11 Oct: USD 17.15, GBP 13.00 & EUR 14.51 per ounce
10 Oct: USD 17.12, GBP 12.98 & EUR 14.53 per ounce
09 Oct: USD 16.92, GBP 12.86 & EUR 14.41 per ounce
06 Oct: USD 16.63, GBP 12.73 & EUR 14.20 per ounce
05 Oct: USD 16.66, GBP 12.64 & EUR 14.19 per ounce
04 Oct: USD 16.83, GBP 12.67 & EUR 14.29 per ounce
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