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Market bubble? Have we blown it?


Fifteen years ago Say My Name by Destiny's Child was dominating the airwaves, The Sopranos had people glued to their televisions, Mission: Impossible II was pulling in movie-goers in droves ,and investors pushed the value of the Nasdaq Composite Index above 5,000 points, blind to the dot-com crash just around the corner.

Fifteen years later, and the technology-heavy Nasdaq has breached 5,000 once again.

Stock markets around the world are at record or near record highs, and experts are worried.

Last week the US, UK and Germany all saw their main stock market indexes hit their highest levels ever.

Most European markets, including Ireland's ISEQ as well as France, Belgium and the Netherlands, have returned to pre-2008 heights. Japan's main market is at its highest since 2000.

Companies from Ryanair to CRH have seen their valuations soar. CRH's market capitalisation, at €21bn, is on par with the annual economic output of Cyprus. Ryanair's, at €15bn, now exceeds the GDP of Iceland.

"It's hard to identify any asset class as a safe bet at present valuations," said Peter Hensman, global strategist at Newton Investments, a London-based investment management subsidiary of BNY Mellon, which has around £51bn (€70bn) in assets under management.

He joins Citi, Deutsche Bank and Goldman Sachs among the ranks of those now warning that markets are now furiously overbought.

"Stocks with attractive valuation are rare in the current environment of stretched share prices," Goldman's chief US equity strategist David Kostin said last month.

Sovereign debt shows a similar pattern. The price of buying 10-year government bonds in Ireland and many other countries is at record lows. Investors are more confident in these countries' ability to pay back their loans than at any other time in history.

"In September Ethiopia became the lowest-income country to ever issue a 10-year bond, and it did so at a yield of 6.6pc," said Hensman.

"I remember when the US was issuing 10-year bonds at that price. And that Ethiopian bond was two time oversubscribed - demand was twice the amount available - because people are so desperate to get a return for their buck.

"Irish debt is the same. The payout for holding Irish debt which matures in five years is now 0.25 of a percent annually. It never fell that low all through the last decade, through the peak of the Celtic Tiger.

"It doesn't make sense. While Ireland has clearly achieved a lot more than many other countries there is still risk, given its debt burden."

Ireland is not the only country where stock and bond markets share little in common with economic data.

The global economic recovery remains "too slow, too brittle and too lopsided", International Monetary Fund chief Christine Lagarde said earlier this month.

More than six years after the global financial crisis, the IMF expects the world economy to grow by just 3.5pc this year and 3.7pc in 2016.

"This is still below what could have been expected after such a crisis," Lagarde said.

The eurozone is only barely beginning to show signs of recovery. While Ireland is racing ahead, large parts of the currency area are either close to stagnation or still contracting.

Inflation is near zero, a major warning bell. Joblessness stands at 11.2pc.

China's economy, for years one of the fastest growing in the world, put in its worst performance in more than two decades last year.

The US economy's recovery is stronger, but experts say it is still on shaky ground. While unemployment stands at a healthy 5pc, data sets show growth slowed sharply at the end of the year.

A recent survey of fund managers by the UK Chartered Financial Advisors Society found that half of them think corporate stocks in developed markets are overvalued.

"I don't disagree with talk of bubbles is some asset classes," said Aidan Donnelly of Davy Stockbrokers, who is responsible for the company's global direct equity offering and helps to direct investment decisions for private client funds.

"We have seen a lot of defensive investing in the past two years, people investing in safe sectors like healthcare, food, retail and household products. The result is that these companies are now very highly valued - and there is nothing riskier than an overpriced defensive stock."

The cause, experts virtually agree, is the world's biggest central banks. In an effort to kickstart lending, central banks from the Fed to the ECB have brought down interest rates to record lows.

At the same time they have committed to massive quantitive easing programmes, with the ECB buying €60bn worth of eurozone government debt a month.

These conditions are forcing investors in turn to plough into equity markets and riskier products in the search for a return on their money.

"The world has been in easing mode for some time - the ECB, Sweden, Denmark, Switzerland to some degree and China are all still in the middle of their quantitative easing programmes," said David Zahn, head of European fixed-income at Franklin Templeton, the firms that made a killing from buying Irish sovereign debt in the wake of the recession.

Davy's Donnelly estimates that at least 25pc of outstanding European government debt is now trading at below 0pc - meaning it actually costs investors to hold onto it.

"In the past six years, low interest rates and central bank quantitative easing have spurred a desperate search for returns. There is always a risk of a bubble forming when policymakers artificially tinker with markets. There is always the risk of unintended consequences."

Des Doyle, trader at ETX Capital, said even governments were turning to riskier investments. "What really worries me about markets at the moment is the negative bond yields forcing investors into uncharted territory when it comes to chasing return. Norway's sovereign wealth fund announced this month that it has more Nigeria corporate debt than at any time since 2006.

"When people are forced into uncharted territory the likelihood of mistakes is much higher. To quote Warren Buffett: 'It is when the tide goes out we get to see who is swimming naked.'"

But all agree that central bank intervention in markets is unlikely to end any time soon.

"Both the Fed in the US and the ECB are targeting inflation of around 2pc annually. Both are very far away from that; if anything the ECB is barely staving off deflation" said Donnelly.

"We are starting to see signs of a European-wide recovery - retail sales and confidence surveys are starting to improve - but one swallow doesn't make a summer. Sentiment surveys are based on expectations, which can change quickly. Real results, GDP, has yet to actually significantly pick up.

"The US Fed, meanwhile, does not want to risk strengthening the dollar even further by raising interest rates. The strength of the dollar has a major impact on US companies.

"Around 35pc of sales by S&P 500 companies are international. Some sectors, like technology, are even more exposed."

Still, few anticipate that the bubble will burst anytime soon.

"In the short term, equity markets will probably continue to run ahead," said Donnelly.

"They have certainly had a much stronger start to the year than we expected. World equities are up 13.5pc in euro terms in the year to date. I would have considered anything above eight or nine percent a good result.

"Markets will probably pause for breath before the year is out, but full year 2015 will still be a positive. High single-digit growth is not inconceivable."

Peter Sullivan, head of equity strategy EU and US for HSBC, takes an even more sedate view.

"We simply don't think there's a bubble in equities markets."

"The important thing to look at is earnings in comparison to the price of the stock. The ratio at the moment is about half of what it was at the height of the tech bubble.

"In the US they are a bit higher, though still far from what they were in the tech bubble - and remember that three quarters of the world's technology companies are located in the US, and that's a huge growth industry which investors are willing to pay above the norm for. That skews the overall picture."

But Sullivan tempers his views with a caveat. "At the same time, you can't avoid the fact that Apple and Microsoft are both worth more than Germany, than the entire DAX index.

"When you start comparing individual companies to entire countries you should be worried - we last saw it around the dot-com bubble, when Intel's value exceeded that of Spain."

Sunday Indo Business