Loose monetary policies being pursued by central banks around the world, including the Federal Reserve, have the dangerous potential to make existing asset bubbles bigger and possibly create new ones. This may turn a “run-of-the-mill recession into a full-blown financial crisis,” warns Chris Senyek, senior macro research analyst, chief investment strategist and lead quantitative analyst at Wolfe Research, in a note to clients quoted by Barron's. “We’re most concerned about 10 asset bubbles. The question is when these imbalances will unwind,” he adds.
The 10 bubbles that Senyek is watching most closely involve: U.S. government debt, U.S. corporate debt, U.S. leveraged loans, European debt, Bank of Japan (BoJ) balance sheet and related equity holdings, unprofitable IPOs, cryptocurrencies and cannabis, growth and momentum stocks, software and cloud computing stocks, and ETFs.
Significance for Investors
“I’d be very, very careful about growing further the balance sheet of central banks,’’ Sergio Ermotti, CEO of UBS Group AG, said in a Bloomberg TV interview. “We are at a risk of creating an asset bubble," he added. His comments came ahead of an announcement by the European Central Bank (ECB) that it plans to keep rates "at their present or lower levels" through the first half of 2020 and perhaps beyond, per CNBC. Meanwhile, the Fed is widely expected to cut the federal funds rate by 25 basis points at its July 31, 2019 meeting, per another CNBC report.
Senyek's comments on some of the 10 bubbles are summarized below.
U.S. Government Debt. "One of the biggest bubbles in the current cycle...U.S. federal debt levels at post-war highs despite the U.S. economy being almost ten years into an economic recovery."
U.S. Corporate Debt. Non-financial business debt is growing as a percentage of GDP, and debt from non-financial corporations is at a record high.
European Debt. European bonds with negative yields may be “perhaps the largest bubble currently.” Investors are banking on additional monetary stimulus from the ECB.
Bank of Japan Balance Sheet. The BoJ's balance sheet is worth about 100% of GDP, and its heavy purchases of Japanese stocks and ETFs have artificially supported equity prices.
Unprofitable IPOs. The percentage of IPOs from unprofitable companies is a sign of froth in the market that is higher than it was at the peak of the dotcom bubble. Hefty valuations for big money losers such as Uber Technologies Inc. (UBER) and Lyft Inc. (LYFT) are particularly worrisome.
ETFs. Easy money policies from central banks have suppressed volatility, increasing the popularity of passive investing through ETFs. “We are most concerned about many fixed income ETFs invested in securities that have significantly less liquidity than the vehicles that own them.” Fixed income ETFs are enjoying rapid growth, and recently passed $1 trillion of assets globally, per Pensions & Investments.
An economic slowdown has the potential to create a "full-blown crisis" as U.S. corporate debt gets hit by a "downgrade cycle," Senyek warns. Similarly, U.S. leveraged loans, debt incurred by companies that already are highly indebted, are at particular risk in a slowdown, they stand behind a long line of more senior creditors.
By inflating the value of Japanese stocks and ETFs, the BoJ may be "making overall losses much more severe whenever the next downturn hits." Regarding ETFs in general, Senyek is among many observers who fear that the next market downturn will be accelerated as panicked investors dump their holdings.