They're Already Talking about Bubbles Again

Submitted By Michael Michaud

By D.R. Barton, Jr. of Van Tharp Institute

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It’s been just a year since the credit / real estate bubble burst, and there is already serious discussion about another one.

In the current political and economic climate, the global response to the crisis was infusion of trillions of dollars of capital to attempt to reduce the impact of the bursting bubble. With that much extra liquidity chasing the same amount of goods and services (or really a lesser amount, given the global economic contraction), the price of something eventually has to go up.

The game is already afoot.

In places where the economies are a tad more nimble than in the U.S., Europe and Japan, the capital infusion has made a quicker and bigger impact. The manufacturing industries in Asia have recovered much faster than their western counterparts (you didn’t think Americans were going to stop buying big screen TVs, now did you?). Add that to the extra liquidity in the global markets and extremely low worldwide interest rates and you have cash chasing assets again, especially in Asia including Australia. As a case in point, Australia’s central bank has already begun raising interest rates to try to cool off inflationary pressures there.

A cover story in the Wall Street Journal trumpets “fear of a new bubble,” citing some compelling statistics. Included are run-away real estate prices in Hong Kong, Singapore, South Korea and Australia. And perhaps most telling is the fact that risk premium spread—the difference between junk bonds and highly rated bonds—is at its lowest level since February 2008 (before the investment banks Lehman Brothers and Bear Stearns collapsed).

So What?

Financial bubbles at their most basic occur when asset price levels far exceed any reasonable fundamental valuation. And the story always ends the same way. If Asian assets suffered through a bubble-collapse cycle, the ramifications would be felt (and felt strongly) in the rest of the world.

As with all bubbles, the support of the tangential financial markets is necessary. And the equities markets are certainly lending their support. Let’s take a look at an insightful chart from the folks over at Chart of the Day.

The fact there were 6 distinct rallies of greater than 15% during the bear market of the Depression is well known among market followers. This chart shows where the current rally from the March lows fits in with those of the past era.

Bear Market Rally Chart

Bulls could make a reasonable case that this might show that the current action isn’t a bear market rally, but has now escalated to full-fledged recovery. A more cautious view would be that the markets haven’t had time to digest the credit contraction from last fall and that the huge cash injection has merely given the market a “sugar high” and will delay meaningful recovery as it works through the system.

In either case, make sure your profit-taking and stop-loss exit plans are in place. And do take into account the fact that volatility is starting to creep back into the market.

Great Trading!
D. R.

About D.R. Barton, Jr.: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at the Van Tharp Institute

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