“A man who knows the price of everything, and the value of nothing.” – Oscar Wilde
This was supposed to be the description of a “cynic”, however when it comes to asset prices, I think this statement applies to a much larger population. A typical bubble in asset prices is nothing but disconnects between the market price and the intrinsic values of assets (real estate, bonds and stocks).
History has shown that we are notoriously poor at valuing assets – bubbles, booms and busts are a regular feature (there are volumes of books dedicated to this portion of economic history).If we are so bad at this, then is there any hope of being able to foresee bubbles?It will always be very difficult to estimate the size of an asset bubble, the tipping point and other specific characteristics; however with a little attention we will always be able to get a broad sense of areas where there is a potential mismatch in price and valuation. It is almost like steering a small boat in the vast open ocean. For the most time we concentrate on our immediate surroundings, navigating our boat through the icebergs, debris and islands towards our destination. Every once in a while you have to lift your head from the wheel and look into the horizon. You are looking for approaching dark clouds, gathering storms or large waves building up in the distance.
The world of debt and easy money –
The known facts – Nations have borrowed from the future, unfortunately all this capital deployment has not resulted in the growth expected. The forces of capitalism should have caused the purge of this inefficient capital, leading to defaults and correction in asset prices. However these forces have not been allowed to function – interest rates have been artificially fixed (price fixing) and there is the creation of liquidity (Quantitative easing).
I am not here to debate if this was the right thing to do, but as stated earlier I want to take a minute and scan the horizon to check my course and look for changes in the scenery.
The first thing I was looking for was inflation, but that does not seem evident. That would mean that a lot of the money printed has still not reached the real economy. Does that mean it could be in some assets resulting in bubbles?
Government Bonds
You can almost be certain that valuations are disconnected from reality in this asset class. Central banks of developed nations are buying this asset (along with other debt instruments) as a part of QE, Insurers, pension funds and banks are all buying into this “safe asset” partly driven by regulations for “safe capital” and partly to balance the risk in their portfolios. The demand for this safe-asset is truly enormous and possibly not warranted. This asset class is definitely like a large rising wave in the offing. It could come down with a large crash or descend slowly creating the next big wave somewhere else.
Unicorns
We are today seeing a wave of new inventions and future possibilities – Self-driving cars, fracking, electric cars, solar powered homes, space travel etc.… This brave new world is filled with unicorns. Some of them will make the transition into beautiful horses, but there definitely will be some that will have to die out in the market cull. David Einhorn one of the most successful hedge fund managers at spotting unicorns that belong to story books has shorted a few of these technologies. Based on the previous boat analogy – this seems like a group of hammerheads are having a feeding frenzy in the distance.
Chinese Real estate
This is again one of those dark clouds in the horizon. China property developers have been finding it hard to clear inventory, this is not news. However a recent headline stated that the price of a villa in Beijing was equal to that of a private island in Bahamas! This is clear indication that there is a reality check that is still required in this asset class.
Even looking closer home, there could be a bubble in the personality cult that we have created here in India – Only time will tell.
This does not mean that the world is all dark and gloomy, we are surrounded by fantastic companies,
enterprising individuals and intelligent investors who are toiling away to improve the quality of our lives.
But as I said it is always good to take a moment and look into the horizon.