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There could be trouble ahead for developed world equity markets with “frothy” valuations as central banks start shifting policy, according to Deutsche Bank AG.
Price-to-earnings ratios increased steadily after the global financial crisis as waves of monetary stimulus pulled down the yields on safe assets, spurring investors into riskier options. That dynamic may be on the verge of reversing with a turnaround in policy now underway in developed nations other than Japan, Mikihiro Matsuoka, chief economist of the Japanese unit of Deutsche Bank AG, wrote in a note dated July 10.
The average of the standard deviation of stock-market capitalization as a percentage of GDP in seven major developed countries has been approaching the previous peaks of 2000 and 2008, Matsuoka highlighted.
The first sign of the 2008 crisis was a suspension of redemptions at a hedge fund. This time around, signs of a problem may include a deterioration in the quality of securitized U.S. auto loan products, and/or the deterioration of the financing of emerging market countries following U.S. interest rate rises, he said.
And, like the way that the first round of Federal Reserve quantitative easing was the most powerful, “likewise, the first round of the withdrawal of monetary accommodation could well deliver a bigger negative effect on the financial market and the real economy than the ensuing second and third shots of monetary-policy turnaround,” he wrote.
Matsuoka said a number of factors have been preventing or postponing a large-scale and prolonged correction in asset prices:
- Higher nominal GDP growth above long-term bond yield thanks to massive monetary accommodation.
- Shorter cycles of capital investment and capital stock in the real economy.
- Dividend yields rising higher than the long-term bond yield, spurring stock purchases thanks to the search for higher returns and resulting in a rise in price-to-earnings ratios
- The financial surpluses of non-financial businesses in developed countries.
“It would be better to assume that these four buffers will weaken over the long run,” Matsuoka said. At the same time, he said it’s impossible to say now whether the market conditions he describes amount to simple froth, or something more worrying: “We would never know if this is a bubble until it bursts.”