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MONDAY SEPTEMBER 21, 2009Beware "Mini Bubbles"The equity markets continue to grudgingly move higher as evidence of economic improvement continues to develop. This, of course, leads to more and more predictions of imminent doom for equities. Yet, money continues to pour into equities. At the same time, the bond market demonstrates that there is still a huge premium for safety, as yields have dropped significantly in recent weeks. I continue to struggle to reconcile the contrasting messages of the two markets. One of these markets is wrong! I continue to think this is a result of a world awash in liquidity. This liquidity needs to find a home and it is moving quickly from one asset class to another. Often, the move into one asset class is based on the momentum of the price movement for the asset class and can be without regard for the current fundamental economic environment for the asset. This can lead to “mini bubbles.” Last year, at the height of the economic crisis, investors flocked to Treasury securities as a safe haven. Little regard was given to the ridiculous low yields at the time. Many cautioned that there was little chance that investors could make a profit at such low interest rates. Indeed, for those who bought long-term Treasuries last year, they have lost nearly 20% of their capital this year as yields rose from crisis levels to still low, but higher yields today. A popped "mini bubble." Oil saw a similar “mini bubble” last year when prices rose to $147 per barrel, only to see the bubble pop and prices decline to $36! Could oil, along with other commodities, be in another “mini bubble?” Oil analysts suggest that there is a massive oversupply of oil in the markets. OPEC has not been able to maintain production quotas as Russia, in desperate need for hard currency, continues to flood the market with supply. This condition has led one market analyst to suggest that his supply/demand model suggests oil should be trading at $55 instead of its current price of $70. This would indicate there is a $15 premium built into oil prices for reasons other than supply and demand. The leading reason is likely the inflation/weak U.S. dollar trade. While I share this concern, it is providing a momentum trade in oil today. If inflation remains tame and/or the U.S. dollar avoids a precipitous decline, this trade could unwind very quickly. It is difficult to see bubbles until after they pop. Are equities a bubble today? Oil? Gold at $1000? Maybe! In a world awash in liquidity, investors should expect quick and dramatic swings in asset class movements. The way to manage investments in this environment is to maintain a disciplined asset allocation that has reasonable exposure to many asset classes. If an asset class performs well, the portfolio will benefit. Disciplined rebalancing of the portfolio will help alleviate the downside if the price increases are due to a bubble. One thing is clear, chasing “mini bubbles” is always a tough trade! Beware the Mini Bubble!
POSTED AT 1899-12-30 10:23:00.0 |
KEN ENTENMANN, CFA
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The opinions expressed here do not represent the views of Alliance Financial Corporation and Alliance Bank, N.A. This communication is not an offer or solicitation for the purchase or sale of any security, is for general informational purposes only and does not provide personalized investment advice. When making personal investment decisions you should consult your investment adviser or rely on your own research. Copyright 2008.