Jeremy Grantham dropped by FT’s offices to talk briefly about bubbles. The most important point he makes at the onset is that: “There is nothing more dangerous and damaging to an economy than a great asset bubble that breaks - and this is something that the Fed never seems to get.”
Grantham mentions that there are several existing bubbles still in play; real estate markets in the UK and Australia as well as two that could form in the coming years: commodities and emerging market equities. He suggests that it is possible to ride the emerging market bubble because of the slow economic growth in developed countries. He criticizes the Federal Reserves policies under Greenspan and Bernanke:
It is not usual that you get three bubbles in a ten or twelve or thirteen year period. Normally one bubble will chew up twenty years because it leaves such a painful experience people don’t queue up to put their hands on the same stove and burn themselves again. But under Greenspan’s incredible leadership, he managed to give us the tech bubble and then by keeping interest rates at negative levels for three years drove up the housing bubble and then finally the risk bubble - everything risky - was inflated by 2007 and Bernanke has happily picked up the mantle and seems totally unconcerned about creating yet another bubble. He has interest rates so low, banks can’t possibly not make a fortune.
The financial sectors incredible profitability has left even the most optimistic analysts behind. Just as two examples, Citigroup (C) and Goldman Sachs (GS) have reported earnings recently with both above expectations.
One bubble that he leaves out is the Canadian real estate market which continues to recover and exceed its previous peak. Here is a chart from The Economist showing how undervalued or overvalued global real estate markets are:
Source: The Economist
As Grantham mentioned, the US real estate market has returned to its historical norm. While the UK and Australia do stand out, the really scary data point for me is for Spain. Even though prices there have fallen dramatically and transaction flow is anemic, prices are still incredibly overvalued.
The Canadian data point may seem relatively benign but it hides the absolutely crazy real estate market in Vancouver. Just last month, the average detached house there reached $1 million Canadian dollars. There is no doubt that what we are seeing there right now is a bubble. Affordability is non-existent as the average Vancouver home owner is now paying 68% of their disposable income towards their mortgage (compared to 30% for more sane cities like Ottawa). If you don’t believe how crazy Vancouver’s market is, take this quiz: Crack Shack or Mansion?
Of course, the fact that there is an imbalance in one localized geographic area does not make it any less dangerous. After all, the US real estate bubble was really only localized within just a few states. For regulators and the central bank it is incredibly difficult to target these regional bubbles. If you’ll recall this was part of Greenspan’s imbecile defense of the US real estate bubble back at its peak. He claimed that since every real estate market is local there can not be a “bubble” in real estate.
In the FT interview, Grantham mentions his “7 lean years” hypothesis, for those not familiar with it, here is another video in which he explains what he means by that:
Cheap money distorts markets and provides people with a new set of incentives that drives bubbles. So while I continue to believe that Canadian real estate prices will move higher - for now - I dread to consider the consequences for the Canadian economy when the Vancouver real estate bubble implodes.
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