Wednesday, March 5, 2014

Richard Fisher Is Seeing Bubbles
FRB-Dallas President Richard Fisher in a 3/5 speech before the Association of Mexican Bankers in Mexico City warned that the Fed’s ultra-easy monetary policy is inflating speculative bubbles again in the financial markets:
To add insult to injury, there are increasing signs quantitative easing has overstayed its welcome: Market distortions and acting on bad incentives are becoming more pervasive. Stock market metrics such as price to projected forward earnings, price-to-sales ratios and market capitalization as a percentage of GDP are at eye-popping levels not seen since the dot-com boom of the late 1990s. In the words of James Mackintosh, writer of the Financial Times column ‘The Short View,’ a not insignificant number of stocks in the S&P 500 have valuations ‘that rely on belief in a financial fairy.’ Margin debt is pushing up against all-time records. And, in the bond market, narrow spreads between corporate and Treasury debt reflect lower risk premia on top of already abnormally low nominal yields. We must monitor these indicators very carefully so as to ensure that the ghost of ‘irrational exuberance’ does not haunt us again.
Fisher is a voting member of the FOMC this year. He is the only participant of the committee with real-world rather than academic experience working in the capital markets. According to his bio: “In 1987, Fisher created Fisher Capital Management and a separate funds-management firm, Fisher Ewing Partners. Fisher Ewing's sole fund, Value Partners, earned a compound rate of return of 24 percent per annum during his period as managing partner. He sold his controlling interests in both firms when he rejoined the government in 1997.” Let’s have a closer look at Fisher’s list of speculative bubble indicators:

(1) Financial fairy valuations. The Fed released its quarterly Flow of Funds report last Thursday. It showed that the market value of all equities traded in the US soared to a record $34.7 trillion at the end of last year, up a whopping $20.9 trillion since the start of the bull market during Q1-2009. As Fisher notes, total stock market capitalization as a ratio of nominal GDP rose to 1.25 at the end of last year, exceeding the previous 2007 peak of 1.12 and the highest since Q3-2000. The price-to-sales ratio of the S&P 500 rose to 1.54 at the end of last year to the highest reading since Q1-2002.

Fisher didn’t mention Tobin’s Q, which is another valuation metric that can be calculated using data in the Flow of Funds report. It is the ratio of the market value of equities to the net worth at market value of nonfinancial corporations. I adjust it by dividing it by the average ratio since the start of the data. It was 1.44 at the end of last year, the highest since Q2-2001.

(2) Record margin debt. I’m puzzled by Fisher's comment that margin debt is “pushing up against all-time records.” It’s actually been setting new record highs since July 2012 and was at $451.3 billion during January, exceeding the July 2007 peak by 18.3%.

(3) Narrow corporate spreads. The yield spread between high-yield corporates and 10-year US Treasuries was just 280bps on Friday. That’s the lowest since the lows of early 2007, just before the financial system started to come unglued.
(Based on an excerpt from YRI Morning Briefing)

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