An article in Fortune Magazine made a convincing argument that the US economy is threatened by four asset bubbles. It has been only two years since the housing bubble burst and money has moved into other commodities and financial assets so quickly that we have the danger of new market bubbles forming.
The Fortune article is titled “Beware the 4 new asset bubbles” by Shawn Tully and is definitely worth the read. The asset bubbles discussed are: Treasuries, Oil, Gold and Stocks and here is an outline of the arguments made.
- Treasuries: The 10 year Treasury is going for 3.6%.
- This means that if the inflation rate gets above 3.6% then the returns on these bonds will be negative.
- And if the Fed becomes worried about inflation they will raise interest rates, which will drop the selling price of these bonds.
- Either way, there could be big losses for those who hold these bonds.
- Also note, the long term going rate for treasuries is around 5.5%.
- Oil: The price of oil is now going for around $75 per barrel.
- Expensive oil costs about $55 per barrel to extract from the ground.
- If the price stays above the $55 mark for any time then production will ramp up to meet the demand until the price reaches equilibrium.
- Gold: The price of gold is now around $1100 per ounce.
- This is triple the long term price.
- Gold is a commodity like oil and gold mining will increase to meet the demand level of this commodity.
- Large quantities of gold are owned by individuals who are rushing to sell their jewelry and other products at high prices.
- Many industrial applications that use gold will decrease as gold prices increase.
- Stocks: Historically, the average price/earnings ratio (P/E) for the stocks in the S&P 500 is 14.
- The current P/E ratio is 20 which is about 30% higher than the historical average.
- And on top of that, any future growth in the economy will probably be accompanied by inflation. So those who purchase stocks in the future will not only be concerned about the out of whack P/E ratio but will also demand higher returns due to inflation.
Now you may wonder where to put your money; well there just might not be a good place for it right now. Because the Fed vastly increased the money supply to fight the recession, any recovery will contain large inflationary pressures.
These inflationary pressures will cause the Fed to raise rates. As a result the outlooks for all of these investments look gloomy right now and it might be a decade before this ship rights itself.
Related posts:
Thanks for your comment Mr Brakewell. I am going to post about color blindness
Seems like the term “Bubble” in relation to any asset class is this years equivalent to 2007′s term “a perfect storm”. It’s a great term for cocktail party conversation but it isn’t particularly useful in assessing an investment strategy. A bubble is only recognized in hindsight. People were predicting a real estate bubble as early as 2000. It wasn’t until 2008 that the prediction came true. Every asset class with returns that exceed the long term averages is potential bubble. If you
What I want to know is what the “professional investment managers” are telling their retired customers to do about their retirement income? What is being said to retirees that hold these bonds? What will the federal gov do if these start to fail? Bail them out through inflation?
I like Avmed’s definition of a potential economic bubble as “any asset class that has returns that exceed the long term averages”. However I do think that we should pay attention to potential bubbles when we assess our investment strategy.
Both the stock market and real estate had exceptionally high returns for years, and a cautious person would not have taken advantage of their high rates of return, but an incautious person would have ridden their investments right into the crash. Investment is like walking a tightrope and it’s good to be able to adjust quickly, because crashes happen quickly.
I don’t want to sound unpatriotic, but the economic bubble that I worry about is the US Economy. Our country has spent years running deficits and government policies have long favored consumers, while increasing costs and forcing regulations on the productive sector. We have long been able to live beyond our means because the world always loves the Dollar and will happily lend us money in order to gain a stake in the dollar’s stability.
But if the world starts to move away from the dollar, there will be much more American debt then there will be demand for American money and the Fed will be forced to raise interest rates on bonds in order to make anybody want to purchase them. This might drive us into severe stagflation.
On top of it, there is lots of talented labor in India and China that is willing to work for a lot less money than American labor. And those two countries subsidize their productive sector instead of taxing and regulating it like we do.
I’m not smart enough to make any predictions, but there certainly is the possibility of high interest rates throughout the financial system, severe stagflation and a productive sector that has trouble gaining ground.
This sounds more pessimistic than I thought it would when I started writing this comment. But, like Avmed said, “bubbles are only recognized in hindsight” so who knows whether this future will be the one that we see?