Twitter shares jumped 73 per cent in a frenzied trading debut that drove the seven-year-old company's market value to around $25 billion and evoked the heady days of the dot-com bubble.BRENDAN MCDERMID/Reuters
Half a decade out of the U.S. housing collapse and well over a decade after the dot-com crash, worrying signs are already appearing for the next financial catastrophe.
Or so believes Sal Guatieri, senior economist with BMO Nesbitt Burns, who today issued a note on seven warning signs of a possible U.S. asset bubble.
He believes the odds have risen over the past five months that a bubble is forming. The recent turmoil that was seen in emerging markets, spurred by just a mere hint of tighter U.S. monetary policy from the U.S. Federal Reserve, could foreshadow some significant financial instability, he believes.
The following is an excerpt from his report detailing these seven signs:
"1. Stock prices are up 24 per cent in the past year
While low interest rates justify higher stock values, the huge gain of the past year can't be explained by improved fundamentals, as the economy has grown less than 2 per cent y/y and profits have risen a pedestrian 4 per cent. A few technology stocks, with big dreams but even bigger losses, are partying like it's 1999 again – witness Twitter's opening day 73 per cent IPO surge. Surging margin debt (27 per cent y/y on the NYSE) suggests leverage is at play, fuelled by the Fed's unprecedented balance sheet expansion. Still, while stocks aren't cheap, they aren't nearly as expensive as during the dot-com boom, with P/E ratios suggesting only a moderate degree of overvaluation
2. House prices are up 13 per cent in the past year
In fact, prices have surged more than 20 per cent in one fifth of cities in the Case-Shiller index. Investors, notably institutional players, are piling into rental properties, sparking bidding wars. Price gains show little sign of slowing even in the face of cooler sales. While rising prices are a welcome development after crashing 34 per cent, continued sharp gains could prove troublesome for first-time buyers, who will need to take on more debt. Still, home prices are well below bubble peaks and remain low relative to income. Despite the upturn in mortgage rates, affordability remains attractive, while lending standards, though easing, are still generally restrictive.
3. Record junk-bond issuance and narrow spreads
Investors are piling into exchange-traded bond funds, driving high-yield corporate bond yields down sharply. The spread between CCC-rated corporate bonds and 10-year Treasuries is about four percentage points below long-term norms. The narrowing spread between low-grade and investment-grade corporate debt suggests investors are being compensated less for taking on more risk.
4. Subprime auto loans are mounting
Strong investor demand for asset-backed securities has spurred lenders to issue more auto loans to borrowers with low credit ratings. Experian Plc says 36 per cent of car loans issued by banks went to subprime borrowers in the second quarter of 2013, up from 34 per cent a year ago .
5. Student loans are soaring
Growing at double-digit rates, student debt has doubled in the past six years to nearly $1.2-trillion. Alongside bigger mortgages, this means graduates will have less spending power as they begin new careers and families, implying a growing risk for the U.S. economy.
6. Farmland values have risen sharply
U.S. farmland values rose 9 per cent y/y in the first half of the year after jumping 11 per cent in 2012, and have more than doubled in the past decade. While recent softer grain prices should take some steam out of the market, investors could be blinded by dreams of further riches.
7. Money supply is outpacing the economy
Money is the oxygen of asset bubbles: without an increasing supply of credit, investors can't pay higher and higher prices. Money has been growing faster than the economy's ability to absorb it productively, and the extra liquidity is flowing into assets. The extra funds, over and above what households and businesses need to buy goods or invest in equipment, are lifting asset prices. Meantime, back on Main Street, consumer prices remain shackled by high unemployment, intense retail competition and modest household credit growth (excluding student debt).
The Bottom Line
While there is no clear evidence of an asset bubble in the U.S. (is there ever?), the above warning signs suggest the risks are rising, and will continue to rise for as long as interest rates remain abnormally low. The Fed's ultra-loose policy, rather than lifting consumer prices, appears to be stoking asset prices instead as investors are more exuberant than households. Perhaps "irrationally exuberant", as Google Trends suggests no increase in concern despite rising risks of a bubble. This nonchalance could reflect a view that if there is a bubble:
1) It won't pop for some time, as tighter monetary policy (the usual pin) is still far off.
2) When it does pop, the Fed will again ride to the rescue.
Unfortunately, this time the monetary mop could be too worn out to clean up the mess."