Why have some asset prices been so high?

Do they have to be bubbles? And is it so terrible if they fall?  I cover those topics in my latest Bloomberg column, here is one bit:

In a volatile and uncertain time politically, we have observed sky-high prices for blue-chip U.S. equities. Other asset prices also seem to be remarkably high: home values and rentals in many of the world’s top-tier cities, negative real rates and sometimes negative nominal rates on the safest government securities, and the formerly skyrocketing and still quite high price of Bitcoin and other crypto-assets.

Might all of those somewhat unusual asset prices be part of a common pattern? Consider that over the past few decades there has been a remarkable increase of wealth in the world, most of all in the emerging economies. Say you hold enough wealth to invest: What are your options? Well, the stock markets of China and Russia are unsafe and not well developed, and many other emerging economies, such as Turkey and Brazil, have been wracked with uncertainty and political turmoil. So you might take a disproportionate share of your money and put it into high-quality, highly liquid assets. That might include the stocks of the Dow Jones Industrial Average and real estate in London, to name two possibilities.

In relative terms, the high-quality, highly liquid blue-chip assets will become expensive. So we end up with especially high price-to-earnings ratios and consistently negative real yields on safe government securities. Those price patterns don’t have to be bubbles. If this state of affairs persists, with a shortage of safe investment opportunities, those prices can stay high for a long time. They may go up further yet.

These high asset prices do reflect a reality of wealth creation. They are broadly bullish at the global scale, but they don’t have to demonstrate much if any good news about those assets per se. Rather there is an imbalance between world wealth and safe ways of transferring that wealth into the future…

To sum this all up in a single nerdy finance sentence, in a world where wealth creation has outraced the evolution of good institutions, the risk premium may be more important than you think.

In this “model,” price declines do not have to be disastrous, but rather can reflect a kind of normalization.  Do read the whole thing.  The theory also predicts that bond, equity, and Bitcoin prices should all decline at the same time, which is indeed what happened yesterday.


Comments for this post are closed