I spoke with a portfolio manager from State Street who runs some money for us this past week and the subject of inflation came up.
His comment was that he and his team do, in fact, see evidence of inflation everywhere – just not in most of the things that go into CPI (which benefits are based on) or the Personal Consumption and Expenditures reports (which the Fed watches). But there is dramatic inflation in asset prices – in small cap stocks, in junk bonds, in private investment funds, in technology startups, in luxury residential real estate, in commercial property, in the art market, in collectibles, in exotic sports cars, etc.
These are undeniably bubbles, all of them exhibiting the types of classic price rises which are normally accompanied by the idea that “You’d better pay up now or you’ll be paying up even higher next month!”
I don’t typically traffic in anecdotal evidence to make points, but my friend Dave is just back from Boca Raton with this whopper:
“Brought the wife and kids down to Boca to spend the week with my parents. I’ve never seen South Florida like this, over twenty five years of going down there this time of year. All the grandparents in my development had paid to fly their children and grandchildren down for the holidays. There were lines everywhere, nowhere to park in town, all the stores and restaurants were jammed up every day.”
Now obviously Boca Raton and Delray is all rich Jews from New York and New Jersey anyway and there’s a lot of real estate and Wall Street money in the mix to begin with, but still. Asset price inflation has driven up the prices of their homes, second homes, investment properties and retirement brokerage accounts to the point where they’ve simply stopped caring anymore. Retirees don’t typically act this way. It could be a generational thing – “enjoy the money while you’re alive!” Or it could be the adrenalinized giddiness that results from a near-catastrophe followed by investor nirvana.
Lehman and Madoff are now a distant memory and the top 10% of the US, which owns 80% of America’s $67 trillion in financial assets, truly doesn’t give a f*ck anymore.
By the way, I don’t blame them for wanting their kids and grandkids down – otherwise it’s boring as hell. I don’t know if you’ve ever been to Boca before but the basic idea is you wake up, eat breakfast and then spend the whole day bickering about where you’re having dinner. Then at 4:30pm you get in the car and go to Matteo’s, family-style Italian, and they bring out penne a la vodka by the trough until you pass out. Or if it’s somebody’s birthday, maybe you go to Ruth’s Chris, whatever.
One of the most hilarious elements of the new bubble is watching analysts hop from foot to foot trying cope with absurd valuations while remaining constructive at the same time. Witness the actions taken by analyst Richard Davis, who covers software stocks for Canaccord Genuity. On Friday he “realigned” price targets on fifteen stocks in one note, almost all which were trading above even his bullish objectives…
“We wanted to realign the price targets of our better-performing stocks with their ratings as we prepare for another earnings cycle,” writes Davis.
“Investors should understand that this is simply a maintenance exercise – we remain confident in the fundamentals of our BUY-rated names; however, clients should not read into the magnitude of price target changes as a conviction read on the upcoming quarter.”
In English: Yes, we like these stocks, but definitely don’t buy them up here at these insane prices.
The end result is he’s got stocks like Splunk, Pegasystems, Workday, Demandware, Marketo, AspenTech and Benefitfocus garnering up to 20x Enterprise Value to Revenues multiples. The pretzel-esque contortions he goes through here to act as though any of these valuations are reasonable should guarantee him a spot with Cirque du Soleil. But what else can he do? They keep doubling! There were $11 billion worth of takeovers in the marketing and infrastructure software space in 2013, Oracle just bought out Responsys for $1.5 billion on Christmas Eve!
The thing about bubbles is that some of them pop and some never do. Some of them go out with a whimper rather than a bang, like the law school bubble for example. No suicides or blaring headlines yet, just quiet desperation and loans that can never be repaid in one lifetime.
Anyway, some of the best articles I’ve read on the topic of bubbles have come out in the last few days. I wanted to share a few of them:
Justin Fox at HBR:
The bubble has become an inescapable element of modern economic discourse. Every day somebody is proclaiming a new one, arguing that there isn’t one, proposing ways to prevent one, orcomplaining about how hard they are to prevent.
What wielders of the term seldom do, though, is say exactly what they mean by it.
What’s That You’re Calling a Bubble? (Harvard Business Review)
Gavyn Davies at FT:
The FT’s “year in a word” series suggested that the spirit of 2013 could be captured in words like “taper”, “sequestration”, “Abenomics”, “selfie” and, of course, “twerking”. I would like to suggest another over-used word from last year: “bubble”. In fact, there was a bubble in the use of the word bubble, especially relating to the S&P 500 index.
How to detect a market bubble (Financial Times)
Chris Brightman from Research Affiliates:
Many of today’s investors uncritically assume that the conditions they have known over the course of their professional careers must be normal. The idea that we may soon experience a multi-decade period of zero or negative growth in real earnings per share, taking the level of profits down to a lower share of national income, seems preposterous.
The Profits Bubble (Research Affiliates)
Jason Zweig at WSJ:
The clearest lesson from history: Worries about a bubble matter less than how the investing public reacts to those worries. By that standard, while today’s stock market is no bargain, it doesn’t resemble the classic overhyped and hyperreactive markets that experts generally agree were bubbles, such as 1999-2000, 1929 and 1720.
When Does a Bubble Spell Trouble? (Wall Street Journal)
Now these are very smart people all trying to figure out the same thing:
Are we in the presence of a bubble? If so, how far along is it? How bad will it be? If it is not a bubble, and yet all these signs are apparent, when will a real bubble arrive and how will we know the difference?
They don’t have the definitive answer because one doesn’t exist. But I do believe the truth about bubbles has more to do with behavior than it does about price alone. Empirically, we’re seeing rapidly rising prices for financial assets and the baubles of rich people everywhere we look. Anecdotally, we’re beginning to see bull market behavior in different areas as well.
No reason to panic, but there’s also no reason to pretend it’s not happening either.
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