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It seems absurd to warn against the dangers of asset price bubbles in financial markets less than three years after the worst global asset price meltdown in more than 70 years
Recent price growth in some financial asset markets has been so rapid that they have started to look like ‘financial bubbles’ in which investment drives prices up above fundamental fair value levels, making some downward correction almost inevitable.
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The currently loose monetary policies of many overseas developed economies have largely created the conditions that would support a new set of financial bubbles – low interest rates and the injection of considerable funds into the banking sector. Ultimately, the surplus money created by loose policies must go somewhere. And much of this money, it would seem, is going into financial assets.
WHERE ARE THE POTENTIAL BUBBLES?
Price growth in five markets has been significant (although it should be noted that some may have had very cheap starting points in the post-GFC environment. It is therefore questionable whether these are truly ‘bubbles’ or just robust corrections.
First, recovery on the major share markets has been strong. Prices in the US hi-tech sector have picked up particularly rapidly, with an 80 per cent jump in prices on the NASDAQ Exchange in the past two years. In light of the ‘tech wreck’ 10 years ago, investors should naturally be cautious; there is, however, now substantial profit being earned by many companies in this sector.
A second sector that has been vulnerable to bubble-like movements in the past is global-listed property trusts (global REITs). Prices have nearly doubled in the past two years and valuations for REITs in the United States now imply a premium of some 20 per cent over underlying asset values.
A third area is commodity prices – base metals in particular – which have returned to a point close to their pre-GFC peak.
Growth in commodity prices has also underpinned the rapid growth recorded in the small mining company sector on the Australian stock exchange – a fourth possible bubble. No doubt much of the boom in commodity prices can be justified by the increased demand generated out of China.
Commodity prices are, however, notoriously difficult to predict. “The main thing we don’t know is how long the boom will last. We know that the peaks of previous terms of trade booms were relatively short-lived,” Reserve Bank Governor Glenn Stevens said just last month.
Finally, higher interest rates here have also helped maintain an exceptionally strong Australian dollar, pushing the cost of goods and services to foreigners to a level well above that of many other comparable nations.
Calculations of underlying ‘purchasing power parity’ suggest the currency should be in the 70 to 75 US cents range. Therefore, it remains possible that the Australian dollar may adjust downwards should the drivers of value, such as commodity prices and interest rate differentials, change.
NOT ALL MARKETS ARE OVERVALUED
Luckily for investors there remain several asset markets in which price growth has been moderate and valuations remain attractive. Non-resource stocks on the Australian share market appear to be providing high and sustainable dividend yields, while rental yields on non-residential property in Australia suggest favourable valuations remain.
For fixed interest investors, government bond yields in Australia provide a comfortable margin above inflation, while the solid state of company balance sheets suggests current yields available on corporate debt securities are also sound value.
