Your Mind On Money

The term “asset bubble” is the talk of the town right now. According to material on Bloomberg.com the topic is being addressed by economists and investment strategists around the globe as world stock, bond, and commodity markets continue to rise with apparent impunity. An asset bubble occurs when the value of an assets class, such as real estate, stocks, bonds or commodities rises in price far beyond what can be justified by supply and demand forces or basic economic fundamentals. Asset bubbles are almost always connected to some type of economic or monetary policy imbalance that is often undetectable while it is occurring. For example the asset bubble in housing that burst in late 2007 was connected to a simultaneous asset bubble in credit that was in turn was connected to a policy of artificially low interest rates following the 9/11 attacks and dot.com bubble collapse. The dot.com bubble collapse refers to the NASDAQ stock market crash in internet and technology stocks that occurred in 1999-2001. The bubble in technology companies was driven in part by venture capital firms who were able to get access to cheap capital as a result of the low interest rates following the Asian financial crisis of 1998. The problem with asset bubbles is that they always eventually pop. And when an asset bubble pops, the results have been historically catastrophic for the rest of the real economy as well. I’ve come to the conclusion that bubbles never look or feel the way that you think they should. I’ve been through two major asset bubbles in my career, the dot.com and the credit crisis, and while hindsight is of course 20/20, I have learned that it is very difficult to discern an asset bubble while it is actually occurring. That’s because bubbles occur when irrational greed (or sometimes fear) completely overshadow logic, reason and balance. While the asset class in the US that would be highest on my list for potential bubbles right now would be US Treasury securities, I do not actually believe that we are experiencing an asset bubble in the US at this time. While Treasuries may be overpriced right now, it would actually be an unlikely place to find a true bubble. Globally if I had to pick a bubble it would definitely be the Chinese stock market. But with that market off 40% from its peak value in late 2007, it’s a little difficult to compellingly make that case as well. The reason however, that this topic is being discussed around the globe right now is because remember that asset bubbles are typically connected to an underlying economic imbalance. While these imbalances aren’t always clear, right now the economic imbalance is quite clearly identifiable. I, like many investment strategists, believe that the aggressive actions to stimulate the economy by the Fed and the Federal government are laying the perfect foundation for the next asset bubble. Knowing that this bubble could be out there I believe that investors should take extra caution and remain extra vigilant in their portfolio strategies for the foreseeable future. I know the financial markets look attractive right now, but they need to be managed with care.