19/10/18: There's a Bubble for Everything

Pimco's monthly update for October 2018 published earlier this week contains a handy table, showing the markets changes in key asset classes since September 2008, mapping the recovery since the depths of the Global Financial Crisis.

The table is a revealing one:

As Pimco put it: "The combined balance sheets of the Federal Reserve, European Central Bank, Bank of Japan, and People’s Bank of China expanded from $7 trillion to nearly $20 trillion over the subsequent decade. This liquidity injection, at least in part, underpinned a 10-year rally in equities and interest rates: The S&P 500 index rose 210%, while international equities increased 70%. Meanwhile, developed market yields and credit spreads fell to multidecade, and in some cases, all-time lows."

The table points to several interesting observations about the asset markets:

1. Increases in valuations of corporate junk bonds have been leading all asset classes during the post-GFC recovery. This is consistent with the aggregate markets complacency view characterized by extreme risk and yield chasing over recent years. This, by far, is the most mispriced asset class amongst the major asset classes and is the likeliest candidate for the next global crisis.
2. Government bonds, especially in the Euro area follow high yield corporate debt in terms of risk mis-pricing. This observation implies that the Euro area recovery (as anaemic as it has been) is more directly tied to the Central Banks QE policies than the recovery in the U.S. It also implies that the Euro area recovery is more susceptible to the Central Banks' efforts to unwind their excessively large asset holdings.
3. U.S. equities have seen a massive valuations bubble developing in the years post-GFC that is unsupported by the real economy in the U.S. and worldwide. Even assuming the developed markets ex-U.S. are underpriced, the U.S. equities cumulative rise of 210 percent since September 2008 looks primed for a 20-25 percent correction. 

All of which suggests that the financial bubbles are (a) wide-spread and (b) massive in magnitude, while (c) being caused by the historically unprecedented and over-extended monetary easing. The next crisis is likely to be more painful and more pronounced than the previous one.