The Coming Market Crash: Today's Bubbles
Markets crash when financial bubbles burst. Certainly, today's financial market has its share of bubble candidates. Famous "Gloom, Boom and Doom" monger Marc Faber noted in the Financial Times last week that the only global asset that isn't in a bubble is the U.S. dollar. That being said, here are my own top three bubble candidates.
Bubble # 1: Global Property
Although the air is being let out of the property bubble in markets as diverse as Florida and Spain, the global property boom trundles on. Big bonuses on Wall Street and London, recycled petrodollars from the Middle East and Russia, combined with looser lending standards for the Average Joe, have driven property prices up across the globe. Property in central London is reaching dotcom era levels of absurdity. A two-bedroom flat in Mayfair -- a tony part of London -- last week went on the market for $3 million. After attracting 14 bidders, it was sold for close to $5.4 million -- 85% above its asking price. To get a 6% gross yield, it would have to rent for $27,000 per month.
Bubble # 2: Private Equity Boom
Private equity today suffers from the familiar and often fatal symptoms of a financial bubble: "too much money chasing too few goods." Companies that were valued at PEs of 12, are now being sold for 20 to 30 times earnings. The fuel for this particular financial fire is low interest rates. For the first time ever, some banks are lending out money below base rates. And they're doing this with "cov-lite" ("covenant lite") terms that give little legal recourse when things go awry. Justified by plenty of "this time it's different" thinking, banks' looser lending standards may be planting the seeds of their own demise.
Bubble # 3: "Chindia"
Scan any business bookshelf in your local bookstore, and you'll be struck by the number of books with the word "China" in the title. Financial newsletters touting Chinese stocks are the top-selling newsletters around. Books on India are slightly harder to come by -- hence the new term "Chindia," which binds the economic juggernauts together in one convenient slogan. The apparent inevitability of Chindia's domination in the 21st century mirrors predictions about Japan 20 years ago. Another worrisome sign of the Chindia bubble? Time magazine featured both India and China in cover stories over the past six months -- a terrific contrary indicator.
The Coming Market Crash: The Causes
The reason for the coming crash will be clear as day -- with the benefit of 20/20 hindsight.
Today, that reason is still murky. But here are some guesses.
Cause #1: A Sharp U.S. Slowdown
Conventional wisdom has it that the United States has successfully weathered the worst of the recent economic slowdown. Yet a handful of economists predict that the combination of skyrocketing debt as a percentage of GDP, the slowest corporate earnings growth since 2002, and the collapse in the housing market will cause the global economy to fall out of bed. Although European commentators revel in their observation that the U.S. economy isn't quite the big kid on the global economic block it once was, it's still the case that when the United States sneezes, the world catches a cold.
Cause # 2: Rising Interest Rates
Change the interest rate assumptions behind all those spreadsheet models that justify the investments by private equity firms, and the private equity financial locomotive can quickly become derailed. Ditto for commercial real-estate deals. Every financial mania also has its iconic transaction that portends its collapse. Remember Jerry Levin and Steve Case shaking hands in the AOL-Time Warner (TWX) deal? Blackstone's (BX) IPO last week -- and Steve Schwarzman's $9 billion fortune -- just may turn out to be that transaction in the private equity era.
Cause #3: The End of the China Mania
When the China market crashes, it will be the most telegraphed crash in history. Ironically, the Arab markets -- which, like Shanghai are off limits to global investors -- crashed just 18 months ago. No one noticed. But like the Middle Eastern markets last year, China's market collapse is not a question of if, but when. No market in the world -- including the United States in the 19th century -- emerged as a global economic power without massive booms and busts in financial markets. To claim China will be different is simply ingenuous. The only real question is whether global markets will have the stamina to shrug China's collapse off -- or will China drag Western markets down with it.
The Coming Market Crash: What Is to Be Done?
Analysis is easy. Taking action is hard. Getting the timing right is almost impossible. I know several London property owners who exited the market two years ago. Today, they are living in rented accommodations -- and are farther than ever from getting back on the property ladder. They claim they weren't wrong -- just early. Time will tell.
The almost uncontrolled growth of credit, trade and derivative flows makes this both a heady and uncertain time in global financial markets. As one commentator pointed out, anyone who says he has found an answer has not done his analysis.
But all this hand-wringing is perhaps the best news of all. Financial manias peak when the future is clear blue skies as far as the eye can see. Financial headlines about a coming crash may themselves be a contrary indicator. The mere talk of a crash provides a "wall of worry" for the markets to climb.
