The CFA Society of the UK, in a poll of its 11,000 “investment professional membership,” put the conclusion into the headline:
Perception jumps of Developed Market Equities as overvalued, as indication of ‘Bond Bubble’ becomes more extreme.
The Fed has floored the monetary accelerator with its steel-capped, lead-lined boot for over six years. Other central banks have followed. They expected, or pretended to expect, that it would create demand, economic activity, and consumer-price inflation.
None of which happened.
Turns out, they didn’t give the free trillions to consumers living from paycheck-to-paycheck – or those living without a paycheck – who’d actually spend this money on things needed or wanted for daily life, to be consumed in a minute or used up over a few years. instead, central banks shuffled these free trillions to their banks from where they flowed in a myriad ways into financial assets of all sorts around the globe, including securities that funded the US fracking boom.
It ended up creating demand for financial assets and asset-price inflation, not consumer demand and consumer-price inflation. It sent stocks and bonds soaring, while yields plunged. Numerous government bonds are now titillating us with near-zero to negative yields.
Investment-grade corporate bond yields plunged too and are now minuscule, if still largely positive. Even junk-bond yields. They average about 3.9% in Europe and 6.3% in the US, though these bonds have an appreciable probability of default and should reward investors for the risks they’re taking.
In the chase for yield, trillions were being plowed into creating supply, such as the US oil-and-gas boom, just when demand was lackluster. Hence, downward pressure on prices, and an environment of low inflation as a consequence of loosey-goosey monetary policies.
“Repeat after me: Easy money is deflationary,” wrote Ed Yardeni, of Yardeni Research, in his Morning Briefing on March 23: Easy money has stimulated supply “because producers overestimated the ability of easy money to boost the demand for their goods and services. Easy money allows ‘zombie’ companies to stay in business, thus boosting supply, even though they are losing money.”
Hence the glorious boom and devastating bust in the US oil-and-gas sector that we’ve been poking at for years.
“Needless to say, the central bankers don’t get it,” Yardeni wrote. They insist that they must continue to provide free money to create demand and inflation “which perversely is deflationary since it is inflating supply more than demand.”
And this, Yardeni explains, leads to the “insanity trade”:
It is widely believed that Albert Einstein said that the definition of insanity is “doing the same thing over and over and expecting a different result.” As long as central banks continue to pour liquidity into the financial markets to boost inflation, the “insanity trade” should continue to work. It’s insane to imagine yields falling much further below zero in the Eurozone, but they do make US bond yields look mighty attractive still, even though they are insanely low too, though still above zero. Global stock markets should continue to rise, and possibly melt up, even though valuation multiples are getting a bit loony in the US. Commodity producers should remain depressed losers, while commodity users should remain manic winners.
But the “investment professional membership” of the CFA Society of the UK, the folks who’ve been plying the “insanity trade” for years, just how insane do they think valuations have become?
In the poll, the CFA UK found that 76% of its 11,000 members considered corporate bonds “somewhat overvalued” or “very overvalued” – an 11% jump from a year ago, and the highest level in the history of the survey. Only a tiny 5% thought corporate bonds were undervalued.
Government bonds fared even worse: 81% of these investment professionals thought they were overvalued, making them the most overvalued asset class. Only 3% thought they were undervalued. I assume those were the folks that accidentally checked the wrong box. There are always a few.
Even stocks, the sacred refuge that you cannot lose money with, as central banks around the world are trying to teach us: the number of respondents that considered them overvalued jumped to 52%, and only 18% consider them undervalued.
Buy low, sell high? So hit the sell button, all at the same time?
In an environment where nearly all financial assets are overvalued, many professionals have become comfortable with them. They know they’re overvalued, but they figure that they can become even more overvalued as long as central banks keep doing what they’ve been doing. But it won’t be easy.
These folks “feel that the prospects for additional benefits from QE may be limited,” explained CFA UK CEO Will Goodhart. They “see the search for returns as becoming even more challenging.” And for pension funds and insurance companies, “the prospect of a long period of low returns will be a concern.”
That would be the optimistic scenario.
And when they do click on the sell button, at first one after the other, and after seeing what the others are doing, perhaps in unison in order to save what they can? It would come at a time when liquidity in the bond market is drying up, when leverage has reached extremes, and equity valuations have become, as Yardeni phrased it, “a bit looney.” It would create some very special fireworks. But not yet – that’s the consensus.
The negative-yield experiment in Europe is triggering the first perversions. This is just the beginning, a new trend that’ll turn into the next craze. Read… Dumping American Junk in Europe, Draghi Asked for it
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