Rates and No-Win Scenario for Shares and Property

The bears, it seems, are now queueing up to warn that the remarkable rises in nearly all assets in 2009 is likely to end in another crash.Economist bubble

Today The Economist stepped forward. It says low interest rates have persuaded investors to seek out better returns, buying ‘risky assets’.

On shares…

It warned that the US market is still ‘nearly 50% overvalued on the best long-term measure, which adjusts profits to allow for the economic cycle, and is on a par with two of the four great valuation peaks in the 20th century, in 1901 and 1966.’

On house prices…

The Economist says American homes are priced at around fair value on the basis of rental yields, but that British homes are overvalued by almost 30% – and by 50% in Australia, Hong Kong and Spain.But not a bubble yet…

Today’s leader column also points out: ‘Two classic symptoms of a bubble are rapid growth in private-sector credit and an outbreak of public enthusiasm for particular assets’ [when a cab driver is giving you share tips or telling you about the gold bullion under his bed] ‘There’s no sign of either of those. But the longer the world keeps its interest rates close to zero, the greater the danger that bubbles will appear.’

It suggests emerging markets and commodities are the most likely candidates for bubbles. That will be resisted by believers of the commodities ‘super-cycle’, such as legendary speculator Jim Rogers, a former investment partner with billionaire George Soros. [Jim Rogers on why Britain’s economy is doomed]. He expects the price of gold to nearly double in the next decade, despite already rising four-fold in the past decade.

Interest rates threat

The biggest threat to the elevated levels of assets such as shares and property is a rise in interest rates. But The Economist observes that if world economic growth is slow and then rates won’t need to rise – but profits (and wages) won’t rise fast enough to justify inflated shares prices (and house prices).

If, on the other hand, economic growth, bounces back then rates would have to rise sharply.

‘It doesn’t add up’ – and that’s before you even get on to the issue of the colossal debt problems facing Western nations.

The Economist concludes:

‘Investors tempted to take comfort from the fact that asset prices are still below their peaks would do well to remember that they may yet fall back a very long way. The Japanese stock market still trades at a quarter of the high it reached 20 years ago. The NASDAQ trades at half the level it reached during dotcom mania. Today the prices of many assets are being held up by unsustainable fiscal and monetary stimulus. Something has to give.’

Chilling stuff. This blog and others have made similar warnings. The correction may not be tomorrow, but it will come…