We are indeed living in a strange world where every bit of financial bad news is cheered with progressively excessive enthusiasm by traders and self-proclaimed “investors”. September has witnessed three instances of bad financial data just in the United States of America, which instead of spooking the markets are, in fact, taking them higher. In the case of emerging markets, participants are overjoyed and already-high valuations are getting further extended as Institute for Supply Management (ISM) Data for Manufacturing & Services and Payroll numbers in US came in much below expectations. It would require a great deal of detachment and independent thinking to not get swayed by the mania as the financial world around you is acting incredibly weird, if not downright crazy. When bad news is consistently portrayed as good news – because bad news means more action from central banks – you can be rest assured that financial prices are getting further delinked from reality. History tells us that such stories never end well. Recent history in the 21st century has presented two case studies for any curious student of financial markets who wishes to dwell on such matters.

The first example was in early 2000 when almost all internet companies were touted as revolutionary and path-breaking. Million-dollar valuations (and in some cases, billion) were being handed out to companies for just having ‘dot-com’ in their name. The euphoria and mania towards internet companies was eventually brought down devastatingly when people started realising that the impact of internet would be way more gradual than anticipated. The asset bubble of dot-com stocks got pricked and the pin that pricks the bubble is always Reality with a capital R. Yes, the impact of internet was indeed revolutionary and groundbreaking. The ignorance of participants was in the timeframe of impact and the assumption that the rewards of internet would be evenly spread among a large number of companies. Even 16 years after the dot-com bubble, only a handful of companies like Google, Facebook and Amazon have raked in disproportionate rewards due to the inherent winner-take-all effect that is in-built in the internet ecosystem.  

The boom-bust cycle caused by ignorance-driven mania got repeated in 2008 when the housing market collapsed in the US and led to global pandemonium. The underlying assumption of virtually all participants was that the housing market never goes down in the long run. Eventually, reality showed that if mortgage loans are distributed to all and sundry without any guarantee of asset collateral or income, then the housing market can also collapse like a house of cards. Yet again, Reality pricked the bubble caused by wishful thinking, ignorance and mania. But there was one crucial difference between the housing bubble of 2007-08 and the dot-com bubble of 1999-2000. While the dot-com bubble was limited mainly to equity markets and hence was resolved quickly without deep damage, the housing bubble involved the debt and derivatives market through opaque, exotic instruments like mortgage backed securities. The combination of debt and ignorance can have unimaginably deadly and destructive effects. The result is that we are suffering the consequences and repercussions even to the present day, as the global economy is yet to regain the momentum lost after the financial crisis that erupted due to the housing bubble.

Now we are in 2016. On September 15, it would be the eighth anniversary of Lehman Brothers’s bankruptcy, the cataclysmic trigger to the financial risis of 2008. Dow Jones is back to lifetime high territory. Even Nifty in India is inches away from its lifetime high close of 8996. Nasdaq too managed to hit a new all-time high recently. It speaks volumes of the dot-com bubble that Nasdaq is only slightly higher than the peak reached in 2000. Such was the intensity of the bubble.

The obvious question that now arises is, have we learnt the lessons that previous asset bubbles offered us? Or are we staring at yet another bubble caused by our manic ignorance and wishful thinking?

I would like to hazard a guess. There is no doubt in my mind that we are indeed staring at massive and multiple bubbles. The culprits (ignorance, mania and wishful thinking) remain the same, but the damage would be even more colossal this time as it would be the culmination of past mistakes. Like the previous bubbles, our underlying assumptions would be proven decisively wrong when the day of reckoning arrives. This time, we are assuming that central bank and government interventions will always support falling asset prices and will use all measures to keep prices high. We have come to this assumption due to the repeated interventions by central banks across the globe whenever the economy is facing difficulties in growing or facing deflationary tendencies. Virtually every time growth unravels or an economy deflates too much, central banks show up with bazooka-like quantitative easing, forward guidance, near-zero interest rates and even negative interest rates. If that was not enough, governments undertake even more deficit spending and fiscal stimulus to back up the money printing efforts of central banks.

The world is awash with liquidity yet the developed economies are struggling with anaemic growth and sustained lack of inflation. The developing economies and emerging markets are also facing the onslaught of reduced global demand and lower commodity prices. Amidst this gloomy economic picture, financial markets are behaving as if times have never been better. Asset prices have been distorted beyond recognition. Stocks, bonds, private tech companies, real estate and collectors’ items (art, cars, wines, stamps) are seeing prices that are highly disconnected with fundamentals. Trillions of dollars of government bonds and even corporate bonds are yielding negative returns. This is a bubble that is much more pervasive in scope and nature than what we have witnessed before. The bubble is a result of excessive liquidity caused by too many interventions than necessary. The liquidity is leading to higher asset prices, but is unable to revive and revitalise distressed economies. Japan and most of Europe are like zombie economies of the developed world. A combination of ageing population, extreme indebtedness, near-zero growth and deflationary economy are severe problems which need structural solutions rather than quick-fix liquidity rushes. There is a lot of focus on the problems of China but they pale in comparison to other systemically important countries which have far deeper problems. China is more of a red herring (no pun intended) while the source of future problems may come from elsewhere.

There will come a point in future, when participants and authorities alike realise that monetary policy and liquidity alone cannot solve fundamental and structural issues and are in fact compounding the problems. That would be the bursting of the bubble and would likely be triggered by an earth-shattering event. Like in 2008, this bubble too encompasses the debt and derivatives markets. The lessons about the perils of excessive leverage and indebtedness have still not been learnt. I hope I am wrong about financial assets being in bubble territory and hopefully we will not have to witness the pricking of bubbles again. But if I turn out to be right, then the damage would be excessively severe and it would lead to a reset of the economic world order as we know it.