Although New Years Eve is not yet upon us, there’s lots of talk about bubbles. Having suffered from the popping stock market, real estate and credit bubbles in just the last decade, legions of investors are rightfully wary of anything that resembles an inflating bubble. Clearly people are suffering from loss of value in their homes. The spectacular stock market rally since March notwithstanding, barring a dramatic surge into year end, the 2000-2009 decade will go down in history as the worst decade ever for U.S. stock returns, eclipsing even the Depression-filled 1930’s. We still face significant potential fallout from the credit collapse.
The stock price surge of the past three quarters has occurred not just in the United States but around the world, with some emerging markets setting a torrid pace. Apartment prices in Hong Kong are starting to dwarf anything we experienced at the height of the U.S. real estate frenzy. While gold has surged to all-time highs, almost daily we hear even higher forecasts. These prognostications are eerily reminiscent of the competition among analysts to post the highest price target for dot.com companies in the late 1990’s. Third quarter Chinese industrial production and retail sales growth have each just been reported at more than 16%. Chinese stocks have roughly doubled over the past twelve months. There is growing unanimity that China and other emerging nations are now the engines that will lead us out of this recession and into the next sustainable period of growth.
All of this has developed in just eight months since we were told by government officials, economists and bankers that our economic system was on the verge of a collapse that could conceivably doom the world to a repetition of the Great Depression. As markets plunged almost daily in the first quarter of this year, it became apparent that investors could not stop the bleeding and rescue themselves. Who could possibly save us from our own financial folly?
Ta da! Government to the rescue. Led by U.S. monetary authorities, governments and central banks worldwide opened the financial floodgates and promised to bail out almost every imperiled entity in sight. The United States, the greatest debtor nation in the history of the world, with no cash reserves, pledged the assets of our grandchildren and our grandchildren’s grandchildren to rescue us from our pecuniary sins.
To date those aforementioned asset price surges have at least raised confidence among the upper strata of the investor class. Thank God, the bonuses are safe for the imperiled bankers whose survival was assured by taxpayer rescue.
For hedge funds and other large investors who can now borrow at virtually zero cost thanks to Federal Reserve largesse, there is a massive amount of money available that is not going into business growth but rather into investment assets of all sorts. The apprehensive among us think we see bubbles growing.
Once again the Fed to the rescue. Just this week, from venues as widespread as Paris and Hong Kong we heard a coordinated chorus of Federal Reserve Governors (Bernanke, Kohn and Yellen) and a Federal Reserve Bank President (Evans) all singing from the same hymnal. Their song: No Bubbles In Sight. Is this possibly a coincidence that they all simultaneously addressed a topic not normally one of the Fed’s talking points? I expect we are to infer that this provides justification for a continuation of the policy of making future taxpayer money available to wealthy financiers essentially free for an extended period to come.
We have no way of knowing how far asset prices can continue to rise in an environment of free money. It’s a function of how long investor confidence remains elevated. We do know, however, that there is always a day of reckoning. Asset prices must ultimately relate to their underlying fundamentals, even if that day of reckoning is long deferred. Countless mammoth hedge funds are long but not bullish. Most intend to exit before reversion to mean valuation ensues. History teaches us that the exit doors are narrow and that most won’t escape unscathed.
If the Fed’s masters of the monetary universe can’t see bubbles, who are we to claim better eyesight? On the other hand, perhaps all we need is to evaluate traditional measures of value: price-to-earnings, dividends, book value, sales or cash flow. Finding those readings at historically excessive levels in 1987, the end of the 1990’s and 2006-07, we kept our equity holdings at seriously reduced levels. In each instance our clients’ portfolios performed far better than most. Again today valuations are historically excessive, and we are finding very few stocks at attractive prices through our historically-based selection process. While we can’t guarantee that our valuation-oriented process will again prove foresighted, I’d far prefer to rely on it than to hope the government can defy financial logic and spend us into perpetual prosperity with money that doesn’t exist.
Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.