Wed, 29 May 2013
Worries that Fed policy has created massive asset bubbles aren't substantiated by the fundamentals, says Morningstar's director of economic analysis.
Jason Stipp: I'm Jason Stipp for Morningstar.
With the markets on a general upward trend and some good data in the housing sector, are we in bubble trouble?
Here to offer his take on the possibility of bubbles is Morningstar's Bob Johnson, our director of economic analysis.
Thanks for joining me, Bob.
Bob Johnson: Great to be here.
Stipp: So here we are again with some strong performance and some strong data and some talk that some areas are really getting overheated.
Why would we be talking about bubbles right now, and is that even the correct terminology to use?
Johnson: I get a lot of questions from reporters who say, well, if the Fed pulls back--if they stop buying the mortgage bonds, if they raise interest rates--won't it ruin all of these bubbles that have … been created by all this Fed policy?
And my answer to that is, we're not really in bubble territory. The Fed has been easing, but not much of the money has actually managed to make its way into the economy. And I look at a broad cross-section of categories, and I'm certainly not seeing anything that looks like a bubble, except maybe in the bond market.
Stipp: So you mentioned that broad cross-section of categories and looking at fundamentals. Let's start with the housing market. We got Case-Shiller data [this week]. It showed that prices were up 11% year-over-year. Some folks have said that we might be getting back into bubble territory with housing prices? What's your take on that?
Johnson: I think that's a little bit silly. I think people are looking at a lot of what the Federal Reserve has been doing and saying, look at all the bubbles they've created and all the markets that are up artificially.
But I think when you look behind the curtain, things are not up as much as one thinks, and we're certainly not in bubble territory.
Stipp: One of the reasons is that we're nowhere near the peak that we met before the housing crisis?
Johnson: Right. We're still in the mid-20% range, below our previous high. So we are still well-below where we were, and believe me, we've had inflation since then, we've had population growth since then, and we have lower interest rates since then. And all those things could justify a price somewhere near the old [peak] down the road.
Stipp: Do you think the prior peak is a good benchmark to use for today, or is it something that we might expect to see in the future, in a certain number of years?
Johnson: It's not going to be a perfect adjustment, because you don't know exactly what year we're going to get there and how much inflation in the rest of the economy we're going to have between here and there. So, no, I don't think it's a particularly good benchmark, but it's at least one item I can point to, but there are others as well.
Stipp: So what about affordability? That is another thing you look at.
Johnson: Yes, the National Association of Realtors publishes a set of data that compares the average price of a home to the qualifying income payment, and then it says, what is that median income right now and how do the percentages line up? The higher the number, the more affordable a house is. Typically the Affordability Index has run between 1.2 and 1.4 times income, and it got as low as 1, and now we got as high as 2 in the last several months, and that was great news; it meant that housing was at maximal affordability. We've dipped back just a little, but we're still at 1.9 times. So we are still well within the range where consumers can afford homes. We're fully half a point above where we usually are.
Stipp: And you also did some recent data comparing affordability of homes here in the U.S. against some other developed markets across the world?
Johnson: Yes, and a lot of the criticism you might get for some of that affordability is, what if mortgage rates go up and all of a sudden you're not as affordable?
So there is a group out of New Zealand who, for various reasons, calculated what the different income ratios to property values were throughout the world. And the U.S. was about three times--the house is typically sold for about three times income--while most of the rest of the world is at five. Then you've got outliers like Hong Kong that are as much as 13. Certainly amongst the major English-speaking, English-law countries, we are now the cheapest among them, even compared to, say, Canada, that used to be the cheapest. So on an income-compared-to-the-price -of-a-home basis, which is not subject to the mortgage fluctuation calculation, we are at a very low and affordable level in most markets in the United States.
Stipp: So housing still definitely a bright spot for recovery, but we're nowhere near any trouble spots as far as bubble issues in the housing market.
Let's talk about commodities. All of the stimulus that we've seen in monetary policy has stoked fears that we would see commodities really get out of control. As a real asset, people would put money [in commodities] if they were worried about monetary devaluation. Have we seen that?
Johnson: Not really. You can go anecdotally or you can look at some of the funds that invest in commodities, but think about it: Oil has come back in here a little bit recently; soybeans and corn have come back down, [following] stories of a successful harvest in South America and great plantings here in the U.S. So prices have come back in on those.
You look at a couple of the big commodity funds, and on average we're down about 5% year-to-date.
Everybody is saying, look at what the Fed's doing and it's making things bubble up. Well, commodities sure isn't one of them anymore. And believe me, in 2011 I wrote about the Fed helping the commodities bubble along. But, lo and behold, the forces of supply and demand took over, and we've actually now for calendar-year 2011, 2012, and so far in 2013, been down in terms of commodity prices. So I don't think we're in bubble territory there, either.
Stipp: What about the stock market? We've seen good strength in the stock market, a few stumbles along the way recently, but it seems that the folks who are in rally mode tend to outnumber the bears, at least in the market right now.
Do valuations look like they're entering a bubble territory?
Johnson: I think we're still OK. We're not nearly as cheap as we were. In a recession, you might get down to a 60%, 70% type of valuation ratios, and the right now we're showing the market is just about exactly on its fair value calculated by looking at future cash flows discounted back to current times. That number has been as high as 1.15 in the past. Clearly we're not in a world of cheap markets, but we are a market of fairly valued. So again, no bubble, and therefore no boom, no bust.
Stipp: A couple of areas of the stock market, though, may be looking pricier than others. REITs are one of those potentially. Do you think REITs are in a bubble?
Johnson: They could be. If people are stretching a little bit for dividend yield, certainly [REITs] became an easy thing to grab at, and I know on the price-to-fair-value charts that I look at by group, that's one that's been running higher than the other groups that I take a look at.
Stipp: The Japanese stock market is seeing tremendous growth--a developed market, up over 70% at one point in recent times, year-over-year. Is the Japanese stock market in a bubble? Can we even tell right now due to all the policy that's going on there?
Johnson: There are so many shifting and moving pieces, I wouldn't really want to comment on it specifically. But when a market that moves that fast, and again it's because they've decided to adopt the quantitative easing program here that we had in the U.S. and have tried to boost inflation and lower the currency--everybody [who thought] the market was given up for dead became very excited about it. So that could potentially be one that certainly will be volatile. I'm not saying necessarily that it's radically overvalued, but it's come a long ways in a hurry and that usually means at least more volatility.
Stipp: Here is a tough one, Bob, fixed income. Bonds. Are bonds in a bubble? It doesn't seem like a traditional kind of bubble, where there is enthusiasm and a lot of exuberance about fixed income, but it doesn't look like the valuations are really that great, either.
Johnson: There have been a lot of reluctant buyers, I think, in the bond market. I don't think there's been exuberance, people buying bonds thinking, oh boy, they're a great value. They're buying because the alternatives in CDs are not very good. So that does make it a little hard to call it a bubble.
But on the other hand, a typical spread between inflation and a 10-year bond is about 2% to 2.5%. And even if you posit that last month's 1.1% inflation rate, which is probably not sustainable, that would suggest, if we add the 2% on to that, that you'd be at 3.1% to 3.6% 10-year Treasury rates.
Interestingly, in the last couple of weeks, we've moved from 1.7% to 2.1%, almost 2.2%, on the 10-year. So we've moved back up, but we're still a ways from what's been the normal trend and pattern of what you see between inflation and those 10-year bonds. Bubble is not the right word, but there's surely something that needs an adjustment.
Stipp: So not a lot of bubbles out there in the market. Some areas may be a little bit more overheated than others, but generally we're not in big red danger zone territory when it comes to the traditional bubble that you hear folks worried about.
Stipp: All right. Bob, thanks for joining us and for those insights today.
Johnson: Thank you.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.