Copying and distributing are prohibited without permission of the publisher.

Watermark

Bubble watch: markets need to be needle-sharp

Bubbles_PA_26Jan21_575x375
By Toby Fildes
26 Jan 2021

Even the greats can get it wrong. Eleven years ago to the day, Bill Gross, ‘Bond King’ and co-founder of Pimco, proclaimed that Gilts were "resting on a bed of nitroglycerine".

The UK’s 10 year sovereign bonds were then yielding a smidgeon below 4%. They're now just above zero, at 0.26%, with the five year effectively 0%.

This is despite the UK government being forced into borrowing record sums. So far this financial year, it has raised £271bn, which is £213bn more than last year. The independent Office for Budget Responsibility has estimated that borrowing could reach £394bn by the time the financial year ends in March.

Of course it helps having a friendly buyer who unfailingly hoovers up your bonds. The Bank of England has bought £450bn of Gilts during the coronavirus, pandemic — more than even chancellor of the exchequer Rishi Sunak has been able to borrow.

The Bank’s quantitative easing programme is now £895bn... bringing criticism that it is financing the government's deficit. But that's another story.

Eleven years on, we have a new set of warnings from the financial world's great and good. This time, they are sounding the alarm about stockmarket valuations.

Jeremy Grantham, co-founder of investment firm GMO, is now saying the “long, long bull market since 2009 has finally matured into a fully fledged epic bubble”.

He believes that extreme overvaluations, explosive price increases, frenzied issuance and hysterically speculative investor behaviour have combined to inflate “one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000.”

Gross may have been wildly wrong in 2010, but it would be rash to dismiss Grantham. He correctly called the dotcom bubble of 2000 and the 2008 crash.

With enormous fiscal and monetary stimulus being pumped into global economies, especially since last March — likely soon to be added to by new US president Joe Biden's $1.9tr Covid relief package — the needle that could burst the bubble remains lost in the haystack.

But given where equity valuations are — and are likely to go, if Biden gets his stimulus — contrasted with the true state of the economy, it's hard to fault Grantham’s logic.

The needle could well turn up where we least want it: on the end of a syringe delivering the Covid vaccine.

As Grantham says, once the most pressing issue facing the world economy is solved, market participants will immediately realise that the economy is still in poor shape. Stimulus will be cut back and valuations will be revealed as absurd.

On the other hand, of course, the vaccine might not work effectively. That would cause a monster crash when the news hit the tape.

Boom. That'll be the nitroglycerine going off.

By Toby Fildes
26 Jan 2021