Stock markets flirt with full bubble territory

Stock markets flirt with full bubble territory
With the FTSE 100 back at levels last seen before the collapse of Lehman Brothers, Martin Hutchinson asks whether there is a bubble brewing in asset prices.

Published: 11:36AM GMT 29 Dec 2009

Rapid increases in the prices of financial assets can be a healthy sign. Markets are doing their job when prices jump because of sudden economic strength or a disruption of supply. But when the causes are more monetary than real, a market bubble is forming. Are markets healthy or unhealthy now?

Observers from the Bank of International Settlements to the Hong Kong central bank are asking the question. And quite right, too. The MSCI World stock price index is up 70pc since March and many commodity prices are rocketing. The Reuters-CRB Metals Index is up 74pc over the past year.

Some portion of those increases is probably healthy. Prices were lowest when the financial and economic worlds were undergoing a near-death experience. Banking systems and the economy are not exactly up and running, but the trends are more positive.

Still, some markets seem to have moved past recovery into excess. The jump in commodities, probably the most "financialised" markets in the world, comes despite ample current inventories and limited recovery in demand.

Global stock markets are in danger of hitting full bubble territory. Analysts expect global market earnings to increase by 30pc in 2010, and investors are already paying a fairly generous 14 times those expected earnings, according to Societe Generale calculations.

The case for a bubble is supported by day-to-day market behaviour -- prices often fall on good economic news. Investors seem to care less about the prospect of stronger demand than about the possibility that the authorities will tighten up financial conditions.

If past practice is any guide, the tightening will be slow in coming. Central bankers have not yet fully cast off their long-established belief that asset prices aren't relevant to their task of keeping inflation at bay, while governments find it hard to abandon the many pleasures of deficit spending.

Recent experience should teach another lesson. Financial excess leads to destabilising market crashes. More distant history suggests that monetary excess frequently leads to retail price inflation. Tighter money might make the recovery less robust over the next year or two, but would make the world safer for the next decade.

http://www.telegraph.co.uk/finance/markets/6905092/Stock-markets-flirt-with-full-bubble-territory.html