Tags: Chancellor | stock | market | bubble

The Heat's On: 8 Reasons Why Stocks Are Bubbling

By    |   Sunday, 11 May 2014 08:53 PM

Edward Chancellor, a strategist at money-management firm GMO, believes U.S. stock prices are at bubble levels because "most of the conditions under which earlier bubbles have appeared are present in the U.S. markets today." He lists eight such conditions, and warns that "this all bodes ill for long-term investors in U.S. stocks."

The first three are "irrational exuberance, Ponzi finance and overblown growth stories," he says in GMO's quarterly letter to investors.

If you want an example of irrational exuberance, take a look at the initial public offering (IPO) market, Chancellor writes. "The IPO market in 2013 and into the first quarter of 2014 has become particularly speculative." IPOs soared 20 percent on average in their first day of trading last year, he says.

Editor’s Note: 5 Shocking Reasons the Dow Will Hit 60,000

When it comes to Ponzi finance, "manic markets are often marked by a decline in credit standards," Chancellor writes. "We have recently witnessed the lowest yields for junk bonds in history. The quality of debt issuance has been deteriorating."

On the subject of overblown growth stories, investors have snapped up many of the market's hottest growth stocks for reasons as flimsy as those used to justify buying of Internet stocks in the late 1990s, Chancellor says. Those hot stocks include shares in the social networking, biotechnology and Internet sectors.

Chancellor's other five reasons why stocks are in a bubble include:

• "This-time-is-different mentality." Bubbles often arise as investors reason that history no longer is relevant in predicting the future, Chancellor says. "Most commentary assumes that U.S. profits have reached, in Irving Fisher's immortal phrase, a 'permanently high plateau.'" Good luck on that, Chancellor writes.

• "Moral hazard." When market participants believe the government will bail them out of financial problems, bubbles expand, he says. "Whenever a cloud appears over Wall Street, market participants have come to expect more quantitative easing and guarantees of perpetually low interest rates."

• "Easy money." Low interest rates go along with bubbles, Chancellor writes. "An avowed aim of the Fed's quantitative easing has been to push down long-term interest rates in order to boost both the stock market and home prices."

• "No valuation anchor." Realistic valuations are ignored during bubbles, he says. "Most of the recent stock market darlings—Netflix, Facebook, Tesla and Twitter—have little or nothing in the way of profits," Chancellor notes.

• "Conspicuous consumption." That phenomenon occurs during bubbles, he writes. "The art market provides an excellent barometer of the speculative mood," he says. "A bubble in modern and contemporary art, which was evident before the financial crisis, has returned."

Meanwhile, renowned economist Nouriel Roubini of New York University says the debt market is showing signs of overheating, including the heavy issuance of junk bonds and bonds without strong protections for investors.

"All the risky things that were happening back in '06 and '07 are back again to the same level, if not more," he told Fox Business Network.

"So we are in the beginning of a credit bubble, but just the beginning. A year or two from now, with the policy rate still barely above zero, the risk is that it becomes a full-fledged bubble."

There may not be a bubble in stocks now, Roubini said. "But if we're [the Fed] going to exit so slowly, then what's the risk of a bubble one year from now, two years from now?"

Editor’s Note: 5 Shocking Reasons the Dow Will Hit 60,000

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Edward Chancellor, a strategist at money-management firm GMO, believes U.S. stock prices are at bubble levels, and he says there are eight great reasons for it.
Chancellor, stock, market, bubble
Sunday, 11 May 2014 08:53 PM
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