Posted on April 20, 2015
(Originally Published on Axial Forum)
The answer may surprise you, but first a bit of background. There have been signs of financial bubbles throughout global markets: US price/earnings multiples are relatively high, the Chinese equity market is on a tear notwithstanding signs of an economic slowdown, M&A valuations remain near record levels and so on. But, that’s not the whole story.
What is a bubble anyway, you might ask? The simple answer is a bubble occurs when the price of an asset class is bid far beyond its real economic value, typically as a result of mass hysteria, delusion, or misinformation. Bubbles tend to last longer than rational investors anticipate, which is why most short sellers don’t wind up billionaires.
You don’t have to look hard to find recent examples of burst bubbles. Oil is down more than 50% from its 2014 peak. Its drop was even sharper in 2008-2009 when it dropped 65% from peak to trough. Gold, the sure fire inflation hedge, is down almost 40% from its 2011 peak and could still be in a downtrend. These were big events reflecting what has been called the end of the commodity super cycle. Yet both the global and U. S. economies continue to grow.
Many claim that the U. S. equity markets are in a bubble. Yet there is little evidence of any large-scale delusion that is typically associated with market highs. On an inflation-adjusted basis, the S&P 500 has only now returned to its peak level reached 15 years ago at the height of the Dot Com boom and the inflation-adjusted NASDAQ remains almost 28% below its 2000 peak.
While excess leverage can potentially cause future pain, I would argue that the current M&A leverage and resulting high valuations are a realistic response to the “new normal” of very low … read the rest