Shortage of Sellers/Surfeit of Buyers
[Note: the following column is dedicated to the memory of Ned Krahl, a good friend who passed away unexpectedly over the Summer, and whose opinions and sense of humor are sorely missed.]
On an elemental level, every asset bubble in history is reducible to a simple phenomenon: a (relatively) sustained period of imbalance — a “disequilibrium,” in economists’ parlance — between Buyers and Sellers.
Or in layman’s terms: too many Buyers and/or too few Sellers.
(Full disclosure: I’m with a minority of analysts who believe that both stocks and bonds are now trading at — shall we say, unsustainably “lofty” premiums to historic valuations).
Bond Market Bogeyman Sugar Daddy
The foregoing formula neatly explains the bond market bubble: the Federal Reserve has been artificially goosing demand now for years.
Overlooked in the “will they or won’t they” taper drama is the not-so-little fact that the Fed has already injected trillions into the system since 2008, and is continuing to buy something like $85 billion of bonds monthly.
Can you say, “thumb (and elbow and knee) on the scale?”
“Stock Seller Strike”
But what explains the bubble in stocks?
After all, there’s no single player like the Fed gobbling up equities, month after month.
In contrast to bonds, my take is that elevated stock prices are all about supply.
More specifically, lack thereof.
In fact, I see two dynamics playing out in parallel:
One. Seller’s remorse. When it becomes obvious to virtually everyone that stocks are going up, no matter the reason, sellers stop selling.
Those who sold some of their holdings “early” now see them trading 25% or 50% higher . . . and vow to hold on to their remaining positions.
When investors behave this way en masse, you essentially get a seller’s strike — and, paradoxically, even higher stock prices, at least in the short run.
Two. Lack of alternatives.
In a truly broad-based bubble like I believe we’re in now, virtually all assets are overpriced.
To harvest profits in one asset means taking a tax hit, then turning around and trying to figure out what other overpriced asset to buy.
Or sitting in cash, which pays zero interest and is likely depreciating due to (understated) inflation — the flip side of the “quantitative easing” coin.
As they say, “Thanks, but no thanks.”
Where does all this go?
How does it end?
I’m with folks like Jeremy Grantham, whose answers are, respectively, “perhaps even higher, at least for awhile” and “eventually, not well.”
Spillover Risk; Side Effects & Silver Linings
What’s more interesting than the inevitable long run is, “what’s going to happen, short-term?”
We already know the risks; what are the opportunities out there right now?
One play is anticipating that the stock and bond bubbles will spill over into other markets, driving up prices elsewhere (Bitcoin, anyone?).
Undoubtedly, that’s already happened in the art market (“collectibles”), where doodles on napkins by people like Jackson Pollock are now apparently worth millions.
And it’s clearly happened in some housing markets, like Manhattan (et tu, Brooklyn?).
Here in the Twin Cities, prices are up significantly since the double-bottom of 2010 – 2011, but overall are still at least 10% – 15% below the 2005 peak.
Capitalism’s Yin & (Jerry)Yang
Thankfully, bubbles do have some genuinely redeeming qualities.
The “wealth effect” much vaunted by economists (and clearly subscribed to by Greenspan, Bernanke et al) is real.
Unfortunately, given the plight of the modern American middle class, it just doesn’t reach that many people — never mind any supposed “trickle-down effect” (one of my favorite rejoinders to “a high tide raises all ships” is, “only if they’re floating”).
More significant is the salutary effect of asset bubbles on start-up’s and IPO’s (initial public offerings).
When assets are inflated, savvy investors figure out how to become sellers instead of buyers.
Conveniently, promising and/or successful start-up’s (see next) literally have millions of shares to sell, either to private acquirers or to the markets via IPO’s.
Sooner or later, that “supply shortage” noted above has a way of getting rectified (and then some).
“Buy Wholesale, Sell Retail” (or something like that)
For now, though, start-up’s with talent, intellectual property, and actual customers — and a product or service than can scale — can easily fetch multiples of 50:1 or even 100:1 of revenues (never mind income. And come to think of it, never mind revenues, either).
In other words, better to buy Twitter shares in 2010 and sell them in 2014, than buy Twitter in 2014 and ???
Leave them to your heirs?
Yeah, right.
As for the economy as a whole, it means that the companies which are likely to lead the markets out of their next slump, whenever it occurs, are likely being funded and launched now (undoubtedly, along with more than a few Webvan’s).
