In the second of a new series for Investment Week, we ask industry experts....
Where is the next asset bubble?
Jeremy Tigue, head of global equities, F&C
One of the most reliable indicators of bubbles is the investment trust market and the recent launch of the Fidelity Chinese investment trust was a worry, made worse by the simultaneous launch of the J.P. Morgan Brazil investment trust. The last specialist Brazilian investment trust was wound up on 18 December 1998 and the Brazilian stock market has gone up more than six and a half times since then.
Seven years ago, when I changed my strategy to invest more in emerging markets, this was a minority view – now everyone believes it. So one risk we as investors have to be alert to is a rising bubble in emerging markets. Over the short term, I do not believe there will be a bubble, as the long-term arguments in favour of the emerging markets remain strong. While it has not happened yet, I believe it could very easily do so.
The other trend that will have an impact on all of us – and therefore be the next bubble – is the huge increase in government debt. There is too much debt and too little confidence about how it will be repaid. I do not envisage government bonds will be as good an investment over the next 10 years.
Taking all of this into consideration, over the coming decade I anticipate there will be a bust in government bond markets and a bubble, then bust in emerging markets.
Colin McLean, managing director, SVM Asset Management
China’s property boom has the potential to be the next major asset bubble, and the broader risks may not be fully understood. While China’s economy is growing strongly, property prices have run well ahead of sustainable demand. In 2009, residential prices in the larger cities across China soared, with increases of more than 50% in Beijing and Shanghai. Total fixed asset investment accounted for more than 90% of China’s overall growth, with residential and commercial property investment amounting to almost one-quarter of that.
With China’s equity market volatile, and only a small bond market, property seems the safest option for many Chinese investors. The boom has been exaggerated by hot money flowing into Chinese assets in anticipation of a yuan revaluation.
Action by the Chinese authorities to cool the sector has been stepped up recently, but with little sign of success. With local governments dependent on land revenue and encouraged to be entrepreneurial, control from the centre is harder. Land is also a key factor in infrastructure lending. Much of this has been financed through local government funding vehicles, which look vulnerable to any collapse of land prices or sharp credit tightening. Reckless lending was a factor in the sub-prime boom and it is being repeated in Chinese real estate.
Kokkie Kooyman, fund manager, Sanlam Investment Management
Undoubtedly, the conditions for the next asset bubble are being created by the current low interest rates in the Western world. When people earn less than 2% on savings accounts they are being urged to spend and take risks. Almost like an alcoholic looking for the next pub or a reckless driver in search of the next accident.
The asset class that has the growth and invincibility characteristics at the moment is emerging markets. Everything points to a “no-brainer” status – there are low indebtedness levels, sound banking systems and fiscal policies along with excellent demographics (low-age population plus a growing population). Couple this with very competitively priced labour and poor infrastructure (providing opportunities) and it is clear why this is a contender to be the next asset bubble.
The list of why emerging markets will continue to grow at a faster rate is almost endless. Greece, Spain, Portugal, Ireland, the UK and the US (not to forget Japan) have the opposite characteristics and this just enhances the emerging market opportunities.
But what will really fuel the bubble is the supply/demand imbalance. All the global indices and hence large global investors are very underweight emerging markets. The door is narrow, and you know that by investing now, the sheer weight of the capital that must still move to emerging markets will push prices upwards.
Mark Wright, Midas Capital
Capital preservation is the key to long-term wealth creation. That means being able to spot asset bubbles and adjust portfolios accordingly before they burst. Despite extremely loose monetary policy around the world, I presently see no bubbles per se, as the global economy struggles to emerge from the ‘Great Recession’. However, they are inevitable and so investors must always be on their guard.
China will increasingly be the focus for investors as its economy rages on and it impacts the global economy to an ever greater extent. As Chinese financial markets become increasingly open and more liberal, it would take a brave person to bet that it will not at some point fall foul to speculative fever and hit a bump that temporarily derails its rapid expansion. Investors should therefore be vigilant.
Investors should also be wary of the complacency in financial markets regarding the medium- to long-term sustainability of Japan’s fiscal situation. The yen continues to be a strong currency and Japanese government bonds continue to trade on extremely depressed yields/inflated prices. This is despite the accumulation of a massive debt pile and a dire demographic outlook.
Japan’s colossal national debt pile is forecast to reach 240% of GDP by 2014 and it has amassed this debt pile at close to the peak of its population. As its population declines, this will have to be addressed from a shrinking tax base. At the same time there will be considerable upward pressure on government expenditure per person as a consequence of a rapidly ageing population.
Robert Jukes, global strategist, Collins Stewart Wealth Management
Fiscal tightening in developed markets is likely to mean the corresponding growth drag is offset with interest rates being held low for longer than many expect. One thing we already know about low interest rates is they tend to stimulate inflation and inflation in asset prices in particular. One reason is low rates tend to drive down risk premia. As this process takes hold over the next year or so, and as the over-exuberance starts to develop, a bubble in risk assets would seem likely. The key, as ever, is separating the over-exuberance from rational expectation, and these boundaries are most likely to become blurred in the equity space within emerging markets.
We have noticed a discernible relationship between the private consumption share of GDP. While we are confident this relationship will continue to hold, we believe countries will start to reposition both up and down the trend line as economies rebalance. Those nations with high savings will likely increase the consumption contribution to GDP and FX appreciation will further empower the consumer and fortify this development. Correspondingly, some nations will need to consume a little less; we treat with particular caution economies in which consumption is steered by foreign transfers of income generated overseas, thereby increasing correlations with the S&P and world trade, and potentially making future productivity gains through capital building more episodic.
We believe that analysts may be over-appreciating the relative growth potential of those nations with the least attractive economic fundamentals and are in danger of appearing over exuberant. Our relative valuation chart confirms that these same nations look rather frothy, and that Brazil, Indonesia and Mexico stand out as areas of concern, leading us to watch out for a Latin American equity bubble developing in the near future.
Andrew Milligan, head of global strategy, Standard Life Investments
A number of bubble candidates are lining up in the ‘asset allocation steeplechase’. Bubbles usually require a combination of events: a good story attracting investor interest, an overly easy central bank or banking system, happy to open the liquidity tap, markets which can experience supply and demand imbalances, and often a lackadaisical regulator who turns a blind eye, for some time at least.
The shortest odds are probably on gold, in its customary yellow colours. For many gold bugs, the precious metal is the solution to any future inflation or deflation scares. Unsurprisingly, any questions about value are rarely answered. Close behind would be certain emerging markets, in their ‘rainbow’ colours.
The classic argument is that a long-term investor must surely buy growth opportunities when the developed economies are expanding so slowly! Any questions about whether all the good news is in the price are usually ignored. The last candidate, the dark horse, is rather different, namely government bonds. How much bad news can they price in? Well, German 10-year bond yields may have fallen to their lowest levels in 60 years, but they are still well above their Japanese equivalent – so surely Germany is about to enter a lengthy period of Japanese style deflation, pushing prices inexorably higher? I will end by quoting Jeremy Grantham: “The only things that matter in life are the bubbles. The rest of the time, just show up for work.”
Simon James, founding partner, Gore Browne Investment Management
There is one asset class today, which everyone wishes to own.
Government debt looks less attractive than normal as interest rates are low, and deficits large. There is unprecedented supply of new government debt, and the eurozone has its own stresses. The corporate bond market has been strong in the last year, and spreads may be vulnerable to weakening sovereign markets.
Equities look good value, but the uncertainty about future economic growth rates is making prices volatile. Commercial property is also difficult. Cash offers derisory returns.
So people are buying gold.
There have been no major discoveries for many years, while demand from Asian consumers is strong.
People who fear a return into the credit crisis and deflation argue that gold represents a tangible certainty. Meanwhile those who fear inflation also want some. Others, who expect the Federal Reserve to print too much money, reckon that gold remains the only real currency.
But, as gold has no yield, it is very difficult to rationalise what a fair price is. Some argue that gold is still well below the high of 1980 which, adjusted for inflation, is $2300, and so good value. This view has no merit, as the price in 1980 had no basis in valuation.
The absence of a fundamental valuation mechanism causes many people to look at charts, which provides only dubious substantiation, but is widely followed. Right now the momentum is undoubtedly with gold.
When everyone has a reason to buy, and is buying, then the market becomes overbought."
Tom Becket, chief investment officer, PSigma Investment Management
It is interesting to debate the next asset bubble, when many might be brewing already. Many have argued that a peculiar blend of prime UK residential property, developed world sovereign bonds and gold are all in some stage of bubblemania. All arguably are, especially while demand for all three seems shakeable. Of those most likely to go parabolic, Gold seems most likely, as investor interest has gone ballistic in recent quarters, sending gold soaring to record highs.
Given the distaste for most currencies at present, this move is explainable as goldbugs claim the yellow metal the anti-currency. Others have argued that emerging market equities are the next bubble, although after the recent de-rating of markets, they are not in bubble territory but close to fair value. However, I would argue that the next bubble will certainly be EM related and quite possibly will be driven by the emerging powerhouses’ insatiable demand for commodities.
Oil was bubblicious back in 2007-2008 and given the peak oil theory that many experts still swear by, it could be again. Do not rule out soft commodities though, my top pick for the next bubble. Although prices are presently in the doldrums, global demographics, pollution and hydration issues could send prices soaring again, much as we saw in 2007.
