“Edward Chancellor, a strategist at money-management firm GMO, believes U.S. stock prices are at bubble levels because “most of the conditions under which earlier bubbles have appeared are present in the U.S. markets today.” He lists eight such conditions, and warns that “this all bodes ill for long-term investors in U.S. stocks.”
The first three are “irrational exuberance, Ponzi finance and overblown growth stories,” he says in GMO’s quarterly letter to investors.
If you want an example of irrational exuberance, take a look at the initial public offering (IPO) market, Chancellor writes. “The IPO market in 2013 and into the first quarter of 2014 has become particularly speculative.” IPOs soared 20 percent on average in their first day of trading last year, he says.
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When it comes to Ponzi finance, “manic markets are often marked by a decline in credit standards,” Chancellor writes. “We have recently witnessed the lowest yields for junk bonds in history. The quality of debt issuance has been deteriorating.”
On the subject of overblown growth stories, investors have snapped up many of the market’s hottest growth stocks for reasons as flimsy as those used to justify buying of Internet stocks in the late 1990s, Chancellor says. Those hot stocks include shares in the social networking, biotechnology and Internet sectors.
Chancellor’s other five reasons why stocks are in a bubble include:
• “This-time-is-different mentality.” Bubbles often arise as investors reason that history no longer is relevant in predicting the future, Chancellor says. “Most commentary assumes that U.S. profits have reached, in Irving Fisher’s immortal phrase, a ‘permanently high plateau.'” Good luck on that, Chancellor writes.
• “Moral hazard.” When market participants believe the government will bail them out of financial problems, bubbles expand, he says. “Whenever a cloud appears over Wall Street, market participants have come to expect more quantitative easing and guarantees of perpetually low interest rates.”
• “Easy money.” Low interest rates go along with bubbles….”
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