Blowing Hard, Blowing Fast

It’s difficult to see how anyone could be pessimistic in this economy: with consistently low interest rates, a significant increase in big company mergers and acquisitions, growth in the Far East of exponential proportions, and an all-time high in Wall Street and London financial city bonuses, the economy and the markets set look to rock and roll in 2006 – and yet there are still plenty of dissenters. It makes me think that where trouble lurks is in analysts’ and traders’ underestimation about just how large the next bubble is being blown up right now.

Most of the economy naysayers point to inflated oil prices and the unresponsiveness of global equity markets to the impact of artificial ‘tweaking’ designed to get them going again in support of their bearish views, but the examples miss a greater extent of detail in thinking about macroeconomic boom-bust cycles.

When former Chairman of the Federal Reserve Alan Greenspan lowered interest rates dramatically after the market crash of the early turn of the millennium, most were expecting this to have the same designated effect it had had on past markets: namely, to give them a quick shove in the upward direction. When this didn’t happen, people started claiming that the midas financier had lost his touch, but the criticism missed the point. Gone was a market environment where there was plenty of free capital waiting to be released at the right place at the right time: even if equity prices look cheap, if there’s no capital sitting on deposit accounts and in government bonds waiting to pounce on the opportunity of higher investment returns, then artificial processes of bolstering markets are redundant. Having been hit with substantial blue-chip bankruptcies and more than a sixty percent fall in equity prices, it wasn’t just that the U.S. economy was in a dispiriting mood for capital investment, it was that there was very little to go around in the first place.

As is the case with post-scenarios in all market crashes, what capital markets needed was time for the swell of money to accumulate outside the market, and to do that, the right environment had to be present for a sustained period of time. And by all accounts, the environment for capital accumulation couldn’t have been any better than it has been over the last five years. Interest rates have remained consistently low, as reflected in real estate prices. Investment in emerging market economies such as China and India has swelled to an all-time high: not only in the form of direct investment, but this time in the form of corporate cost-saving concepts such as outsourcing.

Add to this that oil prices have been pushing significant highs, for contrary to popular scepticism, periods of high oil prices can be considerable long-term market drivers. For one, just as with any pricing mechanism, what goes up inevitably comes down. The significant uptake in demand from development of emerging market economies such as China and tension in the Middle East has created an over-pricing reaction of oil to above $70 a barrel, but once the global economy has adjusted to this new supply-demand ratio prices will begin ease. And when they do, organisations will find they have more capital than they thought to play with, for the net effect of high oil prices is to force companies to become more prurient with their capital, and cut costs in unnecessary areas that they are only too happy to blow on in times of excess – when the pressure begins to ease, companies accustomed to budgeting for these aberrations feel it first, and the excess capital is felt throughout the market. In addition to this, sustained periods of high oil prices as we have experienced them actually benefit exploration into cheaper technological methodologies of energy usage hugely, as both corporate and government budgets are incentivised towards investment in what otherwise appears like tomorrow’s problem. The irony is that it is in periods of short-term cost-inflations that effective long-term cost-cutting strategies are formulated.

Consider too that there is almost a disdainful belief in another equity boom by some camps. Bull markets are, in a similarly ironic twist, propelled by those of bearish attitudes. It is those that do not buy into the first, second and third rounds of asset price inflation who end up buying in at the fourth rounds, further propelling the bubble to new dizzying heights – in this way, bull markets feed off bearish counterparts, or there would just be one sharp upwards and downward spike in prices – and there are still plenty of bearish speculators to go around to make the next explosion in equity prices all the more viable.

If one looks at the market climate of the early/mid-nineties, and that of today, there are some startling similarities – a post-war Middle Eastern crisis, a booming Asian economy (before the sudden downturn in 1997), post-stock-market-crash bearishness with no shortage of innovation. All are back in vogue, with one key addition: they are more extreme than a decade ago.

Looking at all the indicators, another bubble in tech equity prices seems inevitable, at even more extreme measures. Market regulators ought not to be worried about whether equity prices are going to pick up again, but about how to handle the scenario when they do, for if it takes them by surprise, it may well be more than they are equipped to manage.