November 5, 2013

Bubble That Everyone Admits is a Bubble

By EconMatters

This is one of the few times where the benefactors or professionals who benefit from the bubbles, in this case created by the Federal Reserve, fully and openly acknowledge that stock prices and certain other asset classes are completely divorced from fundamental valuations.

Bubble Comparisons

In the Dot Com Bubble there were portions of investors, mainly the traditional value investors, who voiced concerns regarding actual revenue streams of many of the technology startups, but there was at least a story that could be told that the world was entering a new paradigm with the rise of the internet, and previous valuation models were failing to grasp this new paradigm in technological advancement.

Unanimity & Asset Prices

However, even the most optimistic market participants realize that current asset prices are unsustainable without the continual had of the Federal Reserve. They just will not sell until the Fed stops sending 75, 85, 65 Billion a month in QE stimulus, whatever the light taper number becomes from the Fed at some point. It still is 65 Billion dollars of market injections artificially pushing up asset classes each month regardless of a slight tapering event by the Fed, and given that the market is naturally oriented long anyway, throw in the monthly 401k contributions, and there is no reason to fight the market – thus the bubble continues to build.


Market Acquisitions

I have discussed valuations with executive management of sectors which have substantially underperformed the broader market, and they are acquisitive companies, and from a valuation standpoint their competitors are too expensive to buy. These are sectors which are up year to date 5 and 10%, well below the broader market, and substantially below the momentum stocks, but these executives will not even consider an acquisition after a thoughtful analysis. 

These are companies with large cash reserves that will not consider an acquisition strategy, so what do they do with this extra cash, just give it back to shareholders in the form of stock buybacks, which is ironic because they are buying their own stock at these same overly exaggerated valuation levels.

This further adds to bubbly stock prices as more stock shares are taken out of the market. Furthermore, this strategy almost guarantees future losses on these shares once the Fed stops supporting asset prices with 85 Billion each month.

Google vs. Facebook Vying for Global Internet Dominance

Share Buybacks

Sort of like the homebuilders buying their shares back at the top of the housing market, the exact opposite strategy from an underlying valuation standpoint. The correct method is to buy back shares when one thinks that the market is undervaluing the business prospects through a substandard stock price, and not the other way around like currently exists.

If business was so great why aren`t these executives reinvesting this extra cash in the business itself through organic growth? The reason is that there isn`t the actual real demand for goods and services in the economy, and these same companies need to buy back shares to make their earning`s numbers look better than they are due to a sluggish 2% growth economy.

The Federal Reserve

The interesting part is private equity cannot find anything of value to buy, the professionals all openly speak about the inflated prices due to the current bubble, but yet the Federal Reserve is absolutely clueless to the environment. The Federal Reserve might want to take notice when all the major money managers are openly telling the world for all who will listen that the market is a bubble, that maybe they ought to change policy and address the bubble so that the damage from the bubble when it pops is not so crushing that it sends the global economy into a full blown 10-year recession. 

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