QE3 的可能性：unless we get QE3, it is hard to see what else the US c

Financial markets and China
Bubbles and busts

Apr 27th 2011, 12:04 by Buttonwood

From The Economist

 

WHEN does a bull market become a bubble? And how can we rationally identify when a bubble, by definition an irrational event, will burst? There have been many attempts to answer this question over the years; the shadows of Charles Kindleberger and Hyman Minsky loom over any author who attempt to tread this path.

In a new book, Boombustology: Spotting Financial Bubbles Before They Burst, Vikram Masharamani makes a valiant attempt to add new perspective. Broadly speaking, Kindleberger and Minsky focused on credit growth and on trigger events that allowed investors to believe a new era was in place and thus new valuations might be justified; thus railways in the 1840s and electrification and radio in the 1920s. Masharamani adds plenty of detail on behavioural finance, the idea that investors' actions are guided by psychological biases, and by structural changes in the market, such as financial innovations or new regulations. Thus, the final phase of tulipomania may have been caused by the introduction of options, which allowed investors to make a levered bet whilst limiting their downside.

Readers may be most interested in one of his last chapters, which applies the criteria used in the rest of the book to China. China has seen cheap money, rapid credit growth, a property boom, a dodgy financial system, signs of conspicuous consumption (the art market, skyscrapers), a new paradigm (China will dominate the world) and policy distortions (lending decisions made by central or local government). China's demand has in turn driven the commodity boom.

There is a nice table in Jeremy Grantham's latest  note at GMO which shows the proportion of global commodities consumed in China; 53% of cement, 48% of iron ore, 47% of coal, 45% of steel and so on. Thus if China turns out to be a bubble, commodity prices will presumably collapse including gold. Mr Grantham's focus is more Malthusian; the combination of a rising population and raw materials that are more scarce, or more expensive to develop, will put upward pressure on prices.

I find myself in sympathy with both these arguments which seems a little paradoxical. The smooth nature of reported Chinese growth, the massive government-led investment expansion and the blithe extrapolation of these trends into the future make me very suspicious, but I have no idea when the trend will break. If it keeps going, then I think commodity-led inflation will be a problem; if it doesn't then the world will have a problem generating growth.

Back in the developed world, Martin Barnes of BCA Research has attempted to identify whether equities are due for another bear market after their spectacular rally since early 2009 (the S&P 500 has doubled since its beastly low of 666). the factors he examines are monetary conditions, valuation, the economic outlook, technical indicators and cyclical patterns (such as the Presidential cycle). On the monetary indicators front, he points out that the Fed is unlikely to tighten any time soon and the yield curve is steeply upward-sloping, both supportive factors. He is right, of course, but why isn't the Fed likely to tighten soon? Because of the weakness of the financial system which made the Fed push rates down to zero, ensuring an upward-sloping yield curve. With the system so weak, should the market have doubled?

On valuations, he points out that these are not helpful short-term indicators. He does cite the Shiller p/e (it averages earnings over 10 years to smooth out the cycle) which is 23.3 at the moment. However, he says the long-term average is 20, whereas Mr Shiller's website shows it as 16.4, making the market around 40% overvalued and in line with one of the 20th century peaks in 1966. (Mr Barnes tells me that he has used the post-1950 average.)

As to the economy, well we are not very good at forecasting recessions so that's a difficult one. Neither the ISM or the leading indicator is pointing to recession although, regarding the ISM, Mr Barnes points out that

Bear markets often began when the index was strong and rising

The technical indicators aren't telling us much. As for the presidential cycle, we are in the third year which is the most bullish. But that is because the Fed is supposed to ease policy and, unless we get QE3, it is hard to see what else the US central bank can do.

If we apply the Kindleberger/Minsky model to the developed world, we have easy credit and, arguably, a new paradigm; a commitment by the Fed to prop up asset prices. What we don't have is wild public enthusiasm or a focus on one sector with crazy valuations, like the dotcom stocks. So it's not quite a bubble; more the aftershock period of past bubbles. I'm inclined to agree with Gervais Williams, the smallcap fund manager from MAM whom I met this morning, and who believes that the overall market may be going nowhere for the next 10 years although there may still be scope for investors to make money if (a big if) they can pick companies that will grow their dividends.