There are now two clear views of the market: one based on the fundamentals and another based on momentum.
Those who swear by fundamentals draw attention to the high valuations, the tapering off of earnings revisions and the slow pace of growth, and say that stocks are back in bubble land. Those who swear by liquidity say that the uncertainty of growth in the Western nations will ensure that monetary policy remains loose which, in turn, will mean more funds flowing to non-dollar assets, including emerging markets, pushing up asset prices there.
Sure, the markets may have got ahead of growth in emerging markets, but as long as the taps stay open, the liquidity will continue to gush out to emerging markets. Add to that a new twist in the tale, which says that what’s taking place is a huge shift in power from the West to the East, a momentous change that will be reflected in the markets as well.
Also Read Manas Chakravarty’s earlier columns
In a recent radio interview to the Financial Times, Dylan Grice, strategist at Société Générale, pointed to a deeper reason why we may see huge bubbles forming in Asia and particularly in China. He said that whenever global hegemony shifts from one country to another, it is accompanied by bubbles as money pours in to take advantage of the new opportunities.
Grice specifically talks of the booms of the early 19th century in England, as that country became the unquestioned hegemon in the world. Similarly, the market boom in the 1920s in the US can be said to be part and parcel of the shift in global power to the US that was happening around that period.
Grice makes a very good point. After all, money will flow to where the growth is.
This is what economist Michael Bordo had to say about the boom of the early 19th century, when England became the foremost global power after the defeat of Napoleon: “It began after the Napoleonic wars and the successful resumption of the gold standard in 1821. The British economy began a period of rapid expansion, characterized by both an export boom to the newly independent states of Latin America, and at the same time, important infrastructure projects (for example, gas lighting, canals, and railroads) stimulated investment expenditures. The sale of stocks to finance those ventures, in addition to gold and silver mines (some real, some fictitious) in Latin America, as well as sovereign government debt propelled a stock market boom fuelled by the Bank of England’s easy monetary policy. The stock market boom became a bubble as investors bid up the prices of real and imaginary stocks (for example, bonds from the imaginary South American Republic of Poyais). As always happens, the bubble burst.”
It was soon followed in the 1840s by a speculative mania in railway shares. As Grice pointed out, money flows into the investment of the day—canals, railways, the Internet—till overcapacity builds up and then there’s a collapse. Markets can always be counted on to overshoot.
Of course, not all speculative bubbles are the results of real or imagined power shifts; the dot-com boom had little to do with it. And there have been far more booms and subsequent crashes than there have been power shifts. For example, in the 19th century, there were financial crashes linked to the railways in the 1870s, 1890s and the early 1900s. But the converse seems to hold true—power shifts produce booms.
So will we see another Asian bubble as economic power shifts from the West to the East? After the bubble among the so-called Asian Tigers, the dot-com bubble and the US housing bubble, is it now time for our very own bubble? There is little doubt that we have a convincing long-term narrative that will continue to draw money to our shores. So we may be in a bubble, but it’s a bubble that could get a lot bigger.
But surely we have run up enough in the short run? Deutsche Bank expects “a mild repeat version of the self-reinforcing sequence of events that played out from the summer of 2006-late 2007 (regional M1, or narrow money, growth is already running at a record pace). Over this period the Fed committed to holding rates steady, rate differentials widened out in favour of Asian currencies as regional central banks tightened, rising trade surpluses were also putting upward pressure on regional currencies, and as local central banks acquiesced in favour of FX (foreign exchange) strength to ward off imported inflation, capital flows into Asian risk assets surged”.
That is why Deutsche Bank believes that Asia will likely be gripped in a policy and currency induced mini-bubble in the next six months.
There is, however, very little euphoria in the market at the moment, with almost everybody worrying about high valuations, excessive supply of new shares, earnings not keeping up with the rise in stocks, central bank tightening and so on. The spurt in the price of gold is a clear pointer to investors’ fears. Typically, it’s only after a euphoric phase that bubbles burst.
And if Grice is right and we’re seeing a decisive shift from the West to the East, then the current bubble in markets such as China and India will be one among many more in the years to come.
Manas Chakravarty takes a weekly look at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org