Mark Zandi: Economy not in 'bubble trouble' yet

It's fun to be an investor again. Stock and bond prices have surged to record highs. Commercial property values are way up. Even house prices, which were crushed in the crash, are back near their previous all-time peak.

Is it too good to be true? Given how far and fast prices for nearly all investments have risen since the downturn, it is understandable to worry.

If all is well, the value of a company's stock is tied to its profits and growth prospects. House prices are linked to whether households have the income to make their mortgage payments, and it makes financial sense to own rather than rent. The value of commercial real estate is driven by the rents that landlords earn.

If it is a bubble, then asset prices have come unhinged from the fundamentals that ultimately determine their value. Investors speculate, hoping that if they buy an asset rising quickly in price, they will be able to find another investor to buy it from them at an even higher price.

There are good reasons to be on bubble watch. When bubbles burst, they can cause massive losses for investors and have devastating consequences for our economy.

The bursting of the technology-stock bubble in 2000 wiped out $4 trillion in household wealth, causing a painful recession. The implosion of the housing bubble later in the decade led to $1 trillion in losses for U.S. financial institutions, triggering the worst crisis and economic downturn since the Great Depression of the 1930s.

Even Federal Reserve Chair Janet Yellen recently warned that the lofty stock prices were a threat to the economy. She went so far as to single out biotechnology stocks, which have been on a tear.

But while it is prudent for policymakers to watch out for frothy markets, it is premature to conclude that we have a problem. At least not yet.

Take the stock market. While it appears richly valued, it isn't speculative. Traditional measures of valuation in the stock market, such as the ratio of stock prices to corporate earnings, are only on the high side of where they've been over the long run. Technology stocks may be too high, but even that is hard to say, given the amazing advances in cancer research and social media.

It is also easy to argue that the stock market should be at record highs as U.S. companies have never been as profitable and their balance sheets as strong. They've worked hard to lower costs and improve competitiveness.

On top of this, given the unprecedented steps taken by the Federal Reserve and other central banks since the crisis, interest rates are exceptionally low. While many anticipate that the Fed will soon begin raising rates, there are good reasons to think rates will remain low by historical standards for some time. The cash that stockholders receive through dividends and share repurchases is worth a lot more to investors when interest rates are low.

Housing and commercial real estate looks pricey, but mostly in global gateway cities where foreign investors are very active and at least partly motivated by a wish to put their capital in a safe place. Panicked Russian investors have been investing heavily in New York real estate, Latin American investors in Miami, and the Chinese all along the West Coast.

We can also take solace that the run-up in asset prices has for the most part not been financed with borrowed money. Margin debt used to buy stocks is a bit high, but single-family mortgage debt keeps falling, and loan-to-value ratios on commercial real estate mortgages remain modest.

It was the explosion in mortgage debt during the housing boom, much of which went bad in the bust, that did in the financial system and economy.

The banking system is also in a good place, with capital and liquidity sufficient to gracefully digest much higher losses if asset prices were to fall. It is hard to construct a scenario where asset prices fall sharply enough to undermine the financial system and the broader economy.

None of this is to be taken as a reason for investors to go all in on stocks, bonds, and real estate. Most everything looks expensive and it is clear that the easy money in these assets has already been made. At such high valuations, if anything goes off script, asset prices are sure to decline. Indeed, the stock market is long overdue for a correction.

Policymakers should also continue poking at nascent bubbles. Yellen's comments on overvalued stocks is a good example. Another is banking regulators' recent guidance putting limits on bank lending to highly indebted companies. Using these so-called macroprudential tools is something new for policymakers.

Human nature being what it is, there will be bubbles in the future. It's just that we aren't in bubble trouble yet.


Mark Zandi is chief economist of Moody's Analytics

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