National overview
The mother of all stock market bubbles
According to Warren Buffett’s criteria, current share prices have been the most valued at least since World War II. In the chart below, the ratio of the stock market value, represented by the Wilshire 5000 index of all public stocks, to GDP is more than 25 percent above the previous record high, the peak of the NASDAQ stock market bubble in 2000, which is indexed as 100 in the graph. The seemingly relentless rise of the stock market coincides with the central bank balances that have continued since the Great Financial Crisis. Although the large central banks do not usually focus directly on stock market levels, the purpose of their policy was to drive financial markets to more risky investments, which of course include stocks. Global financial markets are interconnected so that the actions of international central banks can influence what is going on in the US and vice versa. The following table compares the bond holdings of the major central banks with the US stock market. There is a close correlation between the stock market level and the central bank’s bond holdings, but both are expected to grow with GDP, so the following graph compares the ratio of the valuation of the stock market to GDP in the first graph with a similar GDP ratio. for central bank assets. As the debt of the central bank increases in relation to GDP, the share valuations rise in line. Some analysts, including the Fed, cite low real (post-inflationary) interest rates as justification for high stock valuations. Interest rates certainly affect the market in the short term, as recently experienced, but over the long term, the correlation between real rates and the valuation of the shares in the chart above is less than half of the liquidity offered by the central bank. security purchases. The overvaluation of equities is clear to experienced investors seeking markets for historically reasonable values. Meanwhile, the GameStop saga (and there are many other examples to choose from) awkwardly recalls some of the extravagance of the dotcom bubble. Just because the stock market is overvalued does not mean that it can not be further overvalued. The following chart compares the US stock market for the past decade with the NASDAQ bubble in the 1990s and the Japanese stock market bubble that crashed in the 1990s. While US equities are currently at the highest point of Buffett’s ratio, the NASDAQ and Japanese bubbles have risen even further from their starting points. The current bubble could also do so if central banks continually pour liquidity into the financial markets. What is clear from the first chart is that the stock market downturn preceded the NASDAQ bubble and contributed to the recession in 2000, as acknowledged by Fed Chairman Jerome Powell. The bursts of the Japanese bubble have also been linked to a recession. Stocks, however, are an insignificant part of the U.S. banking system, largely unaffected by the NASDAQ bubble, although Japanese banks with extensive cross-holdings have been paralyzed for years. A greater financial risk than a downturn in equities is that historically high valuations permeate the entire financial system. The US stock market is an incident for risky assets worldwide. The differences between lending rates for the U.S. government and high-quality investors have dropped significantly and are historically fairly low. The rates for borrowers with an “undesirable effect” investment under sub-investment are too low. Future turmoil in the bond market due to the inevitable reversal of maximum easy monetary conditions could pose a threat to financial stability, but the biggest risk to the financial system is a downturn in housing, as in the Great Financial Crisis. Real estate is the largest single component of bank assets. Fortunately, as illustrated in the following table, which compares house prices to income, fixed value is about 20 percent lower than the too-long levels of the GFC era. Unfortunately, a recent rapid rise in house prices could change this favorable balance. The chart below shows the house prices rising 20 percent faster than the personal income, which is the fastest rate. Of course, there is a major setback to the pandemic, but if this rate continues, it will not be long before the housing flashes critical warning signs. The Fed’s December plan was to keep rates at the bottom level until unemployment is minimized and inflation exceeds 2 percent, which is expected to last them three years. If house prices continue to rise at the recent rate, it will place another three-year maximum stimulus in the GFC danger zone. The recovery from the pandemic is moving faster than the Fed and many other forecasters expected. In March 2020, the Fed predicted a 6.5 percent decline for the year. Forecasters surveyed by the Philadelphia Fed in May expected a 5.6 percent decline. The 2020 downturn was 3.5 percent, and the same forecasters expect growth of more than 4 percent for 2021, so the overall recovery is in sight. The financial markets are already starting to raise their expectations about when the Fed will start raising rates (about two years), and it will not be surprising if it expects an even closer date in time. . More years of maximum stimulus will cause the stock market bubble to inflate further and possibly create an even more deadly housing bubble. The Fed is determined to give up unemployment completely before any tightening, a worthy goal, but even a slight downturn in the wake of a stock market burst would have serious consequences as a result of the pandemic. The creation of another housing bubble would be catastrophic. The depressed business and labor sectors may not fully recover this year, but all the monetary stimulus in the world will not convert aircraft, pubs and restaurants into homes, nor will flight and service personnel in homebuilders or in other thriving sectors. If the pandemic allows it, cash savings are extremely high and there is a lot of pent-up demand for these people and their services. Unanimous focus on just one goal ignores the significant waste of time and complex consequences of monetary policy throughout the economy. Now is the time for the Fed to stabilize policies and markets, and this needs to be carefully communicated and executed to minimize volatility, such as the 2013 taps tantrum, while inflation may pick up in the short term as the recovery recovers persists, long-term inflation has fallen for forty years, so it is probably not a big problem. The biggest economic risk is financial instability, and despite the large initial work that limits the pandemic panic, it is currently the biggest risk for financial instability. . . the Fed.