New Asset Bubble in the Making

“The Financial World According to Inya” Column,
by Inya Ivkovic, MA

I don’t know about you, but these days, when someone mentions potential asset bubbles in the making, I pay attention. After an obscure market such as subprime lending managed to create such global mayhem, no warning should go unheeded, especially if coming from someone nicknamed “Dr. Doom.”

Who is Dr. Doom? He is an economics professor at Stern Business School at New York University, by the name of Nouriel Roubini. He is also among the so very few who accurately forecasted the very mayhem we are still struggling to survive. Last week, he voiced his opinion again, stating that it appears the recession in the U.S. is over, but that a new asset bubble is in the making, fired up by near-zero interest rates and by the U.S. dollar spiraling right down the toilet. The culprit: this time the axe falls on financial assets.

According to Professor Roubini, equities, corporate bonds, commodities and other similar assets are surging, which is contradictory to weak and slow economic recovery and even worse fundamentals. It seems that we are planting the seeds for the next bubble bursting, just as we did after the tech bubble burst in 2000.

In Dr. Doom’s own words, ‘We have the mother of all carry trades,” which is what he calls the strategy of borrowing one currency at interest rates that are low and buying stocks, bonds or commodities in another currency that enjoys higher interest rates. As more and more traders jump on this wagon in search of profits, they could be adding fuel to yet another asset bubble.

However, as was the case when everything was still hunky-dory in the lending and housing markets, not everyone sees bubbles as Professor Roubini does. In fact, the majority is seeing Dr. Roubini’s seeds of future asset bubbles as the necessary foundation for a recovery. Businesses, institutions, economists, central bankers and investors alike have called for aggressive monetary easing. They got their wish and now the value of financial assets in particular has skyrocketed.

Of course, after more than a year of grueling recession, outperformance in the stock, bond and commodity markets has been more than welcome. No one really wants to rock the boat now when reduced interest rates have brought new life to global equity and real estate markets. No one wants to stop what is apparently helping the global economy pull itself out of the worst economic slump since the Great Depression.

However, what must not be ignored is that financial assets cannot keep up this momentum for very much longer, unless the economic growth returns to normal levels. At the onset of the fourth quarter, it seems that all we have is a paper asset economy and paper economic recovery, both thin and both easily ripped into pieces. What everyone seems to have forgotten, including those who should have learned their lesson, is that assets should appreciate in parallel with the gross domestic product (GDP). So, if GDP is at about four percent to five percent, this should be the return on financial assets, too, even in the ultra-reduced interest rate environment. Instead, we have had about six or so months of abnormal asset appreciation. Whichever way you look at it, this run is very close to peaking, which makes it also very high risk.

In other words, if you are hoping for the traditional V-shape recovery, don’t hold your breath. Let’s hope we should be so lucky to end up with a U-shape recovery and not with an L-shaped non-recovery. Perhaps it is also time to warm up to a different kind of economic equilibrium, one that consists of tight credit, higher inflation, slow-motion GDP and higher unemployment rates.