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A ‘Rational Bubble’? Why Your Home’s Value, Stocks And Bitcoin Are Soaring In A Crisis

It's perfectly rational to believe that today's totally irrational prices will continue.
Tesla CEO Elon Musk, pictured at the Axel Springer Awards ceremony in Berlin, Germany, Dec. 1, 2020, has become the world's wealthiest person on the back of what some are calling a "rational" stock bubble.
Tesla CEO Elon Musk, pictured at the Axel Springer Awards ceremony in Berlin, Germany, Dec. 1, 2020, has become the world's wealthiest person on the back of what some are calling a "rational" stock bubble.

You may have noticed something strange is happening with the value of your investments these days: they’re rising fast in a time of crisis.

With the exception of condo owners in some big cities, homeowners in numerous countries have seen their property values rise since the pandemic began. There’s also a good chance your retirement investments have done surprisingly well lately.

All of this is happening despite a historic economic shock that doesn’t seem to be over just yet; millions of newly unemployed people the world over; and soaring government debt levels. Who even remembers that 2020 began with the fastest stock market crash in a generation?

Watch: Stock market is in ‘fully-fledged epic bubble,’ GMO’s Jeremy Grantham warns. Story continues below.

Digging into the details doesn’t help make much sense of it. How is it that electric carmaker Tesla has soared to be worth US$880 billion, making its founder, Elon Musk, officially the richest person in the world, while the world’s biggest-selling carmaker, Toyota, is valued at less than a third of that, US$250 billion?

At the heart of this story are the world’s central banks ― the U.S. Federal Reserve, the Bank of Canada and the like ― which went into overdrive last spring to rescue a financial system teetering on the brink, dropping interest rates to rock bottom levels, while creating new money and using it to buy up debt from governments and businesses at unprecedented rates.

The result is that the world has been flooded with new cash, at exactly the same time that people have far less to spend on ― no vacations, no sports events, no large summer barbecues.

So if you’re one of the many who didn’t lose their livelihoods, what do you do with your cash? You save it. You buy stocks and bonds, or gold, or you make a larger down payment on a new house.

In some instances, people put their government income support money straight into bitcoin. The cryptocurrency has soared 40 per cent just since the start of this year ― barely more than a week. It closed Friday at a dizzying price of US$42,000 per coin.

Those sky-high valuations are why some analysts are daring to say the dreaded B word: bubble.

Bitcoin over the past two years “blows the doors off prior bubbles,” researchers at BofA Merrill Lynch Global Research recently declared. They put out a chart comparing the rapid rise of bitcoin’s value to previous equity bubbles over the past 45 years. The cryptocurrency’s surge is unparalleled.

This chart from BofA Merrill Lynch Global Advisors compares the run-up in bitcoin prices to previous asset bubbles since the 1970s.
This chart from BofA Merrill Lynch Global Advisors compares the run-up in bitcoin prices to previous asset bubbles since the 1970s.

The alarm bells should be ringing loudly. In fact, a recent survey of 904 investors by E*Trade Financial found 66 per cent believe the market is in a bubble.

And yet it’s clear that the institutional investors, the experts ― the “smart money,” as it were ― believe wholeheartedly in this massive asset bubble. It is, in the words of prominent economist Mohamed El-Erian, a “rational bubble.”

El-Erian, a former advisor to the Obama administration, chief economist at financial giant Allianz, and one of the most respected voices on economics around today, makes no bones about it: This is a bubble, in that the value of investments has become disconnected from their fundamental realities.

“So as long as the Fed remains supportive of markets, the path of least resistance will be up, despite the economy struggling a lot.”

- Mohamed El-Erian

But “this is not an irrational bubble, this is a rational bubble. It’s rational because the Fed and the [European Central Bank] keep on signalling that they will continue to inject massive liquidity, and as long as the market is confident that that’s the case it will drive prices higher,” El-Erian told CNBC on Jan. 7 .

The central banks have made sure the markets know they won’t be pulling away the support anytime soon, issuing “forward guidance” that indicates they will keep rates low, and keep buying debt, at least into 2022.

“So as long as the Fed remains supportive of markets, the path of least resistance will be up, despite the economy struggling a lot,” El-Erian said.

Mohamed El-Erian, chief economic advisor at Allianz, says the current "rational bubble" in asset prices will likely continue so long as central banks keep propping the markets up.
Mohamed El-Erian, chief economic advisor at Allianz, says the current "rational bubble" in asset prices will likely continue so long as central banks keep propping the markets up.

As long as this wave of new cash keeps flooding the markets, “we will continue to have this contrast between what the market is doing and what conditions on the ground are telling you.”

With COVID-19 case counts hitting record highs in many regions, conditions on the ground are starting to look worse. Both the U.S. and Canada reported negative job numbers for December on Friday, the first monthly loss of jobs since the spring lockdowns. Experts are now calling for the economy to shrink once again in the first quarter of this year.

That’s shaking the faith of some people in this central bank-driven “rational bubble” ― but not by much.

Those who bet against the markets this year have been well and truly punished, and there are very few still willing to make that bet. Short positions on U.S. equities (i.e., bets that they will fall) have hit historic lows in recent months.

The world is all in on the “rational bubble.” Here’s hoping it isn’t an irrational mistake.

With a file from Reuters

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