Bubble talk is bubbling away. Housing prices in some markets, such as London, are suspected of floating dangerously close to bubble territory, yet buyers keep buying and prices go ever higher. Ditto the stock markets, whether they are the tech-heavy Nasdaq, replete with companies with no profits – think Twitter – or Germany’s MDAX, which is laden with businesses that make real profits. Up, up, up they go.
Are these markets approaching bubble territory? Hard to say, of course, because bubbles are never confirmed until they burst. Former Federal Reserve Board chairman Alan Greenspan knows a thing or two about that.
But there is ample reason to be worried. While there are a thousand ways to measure the value of an asset – from the price-to-earnings ratio for stocks to rental yields for housing – one thing is fairly certain: When prices get seriously out of whack from their long-term trend, they tend to correct themselves. This is called reversion to the mean.
Why are markets and assets such as housing rising? One reason is that it seems to make no sense to stuff money in the bank. Interest rates in Europe and North America are at rock-bottom levels. In November, European Central Bank president Mario Draghi cut the benchmark rate to 0.25 per cent, an all-time low. One more reduction is not out of the question as the euro zone, in his words, faces “a prolonged period of low inflation.”
In Britain, the Bank of England’s policy is to avoid rate hikes until the jobless rate drops to 7 per cent. That is unlikely to happen for another year. Sovereign yields are low (although still elevated in Italy, Spain and the other countries with an enduring love affair with their crises). Germany can borrow 10-year money at less than 1.9 per cent – money for nothing, in other words. If you are a pension fund or insurance company, you’re not loading up on bonds. You’re plowing it into the stock market, a strategy that has produced pleasing results so far. As central banks keep printing money, stoking up inflation fears, individual investors are doing the same or buying houses in hot markets.
Which brings us to London. Everyone has a different explanation for the awe-inspiring house price increases. You can credit – or blame – the sharp devaluation of the sterling in the 2008 financial crisis, the shortage of new housing, accelerating population growth and the reversal of Britain’s dire economic fortunes. On Thursday, chancellor George Osborne revealed that gross domestic product is expected to rise 2.4 per cent next year, up from the previous forecast of 1.8 per cent. Meanwhile, London has not lost its attraction among the world’s millionaires and billionaires, in spite of the punishing weather. They keep arriving by the Learjet-load from Moscow, Milan, Athens, Madrid, Tel Aviv and Hong Kong, some because they need to be there for business, others because they are diversifying their family wealth and hunting for second passports.
Still, there is something drastically wrong with London housing values. Prices in London are more than twice of those outside the city. In 1997, after several years of recovery from the “negative equity” era of the early 1990s, the average London house sold for four times average personal earnings, compared with 3.5 times for England as whole, the latter figure being in line with long-term averages.
Recession be damned: By the end of last year, the English house price to earnings ratio was 6.7 while the London equivalent was 9.7. The London ratio is now 10 times and could go higher. Or could it?
With London house prices running well more than twice their 1997 price-to-earnings ratio, something has to give, it’s just a matter of time. The trigger could be a rise in sterling or interest rates, the withdrawal of Britain’s rather unnecessary mortgage-support schemes, a surge in the housing supply – a construction boom is under way – or irrational exuberance suddenly turning into rational value-seeking. The best cure for high prices is high prices.
It’s harder to say that the stock markets, fuelled by all that cheap money, are headed into bubble territory. The rise in the U.S. markets – the S&P 500 is up 27 per cent this year – may be justified by the relatively strong recovery, stable energy prices and unemployment and Americans’ famous optimism, which is not always misplaced.
But it should be noted that the latest survey of U.S. investment newsletters found that the bull-bear proportion was four-to-one, the most bullishly high level since 1987. When the herd is all running in the same direction, watch out. The Financial Times’ Short View column noted on Thursday that the highest bull-bear ratio was recorded in 1977, after which shares fell 20 per cent.
The European markets are harder to figure out. Germany’s MDAX index of medium-sized companies is up 30 per cent this year, taking its price-to-earnings ratio to an all-time high. The European economy which soaks up the bulk of the exports of the MDAX companies is coming out of recession. But the recovery is so weak that it barely justifies the name, so it’s not apparent what is underpinning the market surge.
To misquote Shakespeare, we may be entering the era of bubble, bubble, toil and trouble.