Global| Oct 03 2018"Irrational Exuberance" --- Part 3
|in:Viewpoints
Summary
There's an old saying, "fool me once and shame on you; fool me twice shame on me". Yet, who's to blame when it happens a third time? Soaring equity prices along with continued increases in real estate prices in the third quarter have [...]
There's an old saying, "fool me once and shame on you; fool me twice shame on me". Yet, who's to blame when it happens a third time?
Soaring equity prices along with continued increases in real estate prices in the third quarter have lifted the market value of household financial and real assets to a new record high, exceeding the relative valuations of the housing and tech-equity bubbles.
The US Financial Accounts report for Q3 issued by the Federal Reserve will not be published until early December but the 7.2% rise in the S&P 500 equity index alone enables one to make some general conclusions. Here's the top three:
*The market value of household real and financial assets will top 6.1 times the level of nominal gross domestic product, a new record high, exceeding the housing peak bubble of 5.8 times in 2006 and the tech-bubble peak of 5.1 in 2000.
*Household's net worth as a percent of disposable personal income should top 700% for the first time, far exceeding the housing bubble peak of 668% of 2006 and the equity bubble peak of 614% of 2000.
*Household holdings of equities owned directly and through mutual funds should equal a record 25% of the market value of household total assets, surpassing the prior peak of 23% reached in early 2000 during the height of the tech-bubble. The one caveat here is that households have a greater percentage of their equity exposure today in mutual funds, suggesting a more passive role but one that still carries substantial downside risk.
The current strong run-up in asset prices represents the third major asset cycle in the past 20 years. Each cycle has unique characteristics, but it also true that each one shares common elements of high levels of consumer and investor confidence and excess liquidity.
Policymakers often state that it is impossible to identify an asset bubble in real time since it is difficult to determine to what extent fast increases in asset prices reflect portfolio adjustments, perceived fundamental changes in the real economy or excess liquidity.
That public defense may have worked following the tech-equity bubble in 2000 but is it that still an appropriate defense in light of Great Financial Crisis of 2007-09 and the fact that in the current cycle monetary policy has flooded the system with cheap money?
The lessons from the past two asset bubbles are quite clear. First, expectations of business profits and market returns outran the economy's potential to deliver, and when the balance of sentiment shifts and investors realize the economy's fundamentals do not support current asset valuations the adjustments can be abrupt and sharp. Second, there is nothing unique about asset markets that would suggest asset prices can absorb an overly accommodative monetary policy and become unhinged from the growth in output and income flows without ultimately leading to costly real and financial adjustments at some point.
Admittedly, it is always difficult to prove causation but it's hard to deny the strong correlation, if not direct link, between the transparent and accommodative stance of monetary policy and the record high relative valuations in the asset markets. If the current asset cycle follows the script of the past two it would appear to reflect the failure of policymakers to recognize that they allowed the cost of credit for real estate and equity purchases to be too low and for too long.
Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
Joseph G. Carson
AuthorMore in Author Profile »Joseph G. Carson, Former Director of Global Economic Research, Alliance Bernstein. Joseph G. Carson joined Alliance Bernstein in 2001. He oversaw the Economic Analysis team for Alliance Bernstein Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor All-Star Team for Fixed Income and ranked as one of Best Analysts and Economists by The Global Investor Fixed Income Survey. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees. He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Honorary Doctorate Degree, Business Administration Youngstown State University 2016. Location: New York.