Business·Analysis

Pandemic optimism and bubble warnings leave investors wondering who to trust

Rational exuberance that COVID-19 could be slowly headed for defeat and a promise of low interest rates cannot dispel the worries of some analysts about an eventual reckoning as asset prices soar, Don Pittis writes.

Combination of exuberance and low rates may have changed the rules — for now

Are markets heading for outer space? SpaceX and Tesla CEO Elon Musk seems to think so. Maybe it's time to get a second opinion. (Hannibal Hanschke/Reuters)

Hearing any single point of view on the current state of the markets that are again hovering near record highs, you might think market analysis was a science with clear answers.

That feeling may be deceptive. And for many Canadians, deciding what to do with their savings may be more difficult than ever.

Even as markets appear to be propelled by optimism that the COVID-19 pandemic will be defeated and by the promise from central banks that interest rates will stay low for years, the sensation of clarity and certainty may fade when you research more widely.

The latest high priest of market exuberance is Tesla and SpaceX boss Elon Musk, who, to his many acolytes, has established his can-do credentials not just by inspiring the electric car era in the face of naysayers and leading the private sector into space, but bumping out Amazon's Jeff Bezos to become the world's richest person.

Invest like a multibillionaire?

Those credentials have attracted followers. And while the multibillionaire's market views are most often expressed in cryptic tweets and the actions of his companies — this week, for example, Tesla purchased $1.5 billion US in bitcoin — there are others who articulate at least part of Musk's optimistic argument, albeit in a moderate form.

James Mackintosh at the Wall Street Journal is not recommending a bitcoin play, but when it comes to broader market optimism, he makes a rational case for why an expectation of more stimulus and not much fear of inflation have left market investors looking for further gains.

"Investors are predicting the sort of inflation they like, slightly higher in the next few years but moderating back down after that, and it's helping stocks and commodities while limiting the pain to bondholders from rising yields," the WSJ investment editor wrote in Tuesday's paper.

Stocks on Wall Street and Canada's Bay Street hit new record highs this week as some analysts say we are in a sweet spot with low interest rates, big spending and low inflation. (Carlo Allegri/Reuters)

Markets, which are a bit like voting with your money, demonstrate that a lot of people agree with Musk that asset prices, whether stocks or Canadian real estate, have more room to rise.

Also, markets were never supposed to tell you what is happening now. These days, Canada's economy is weak and recently gave up more than 200,000 jobs. Instead, the theory is that high stock prices now tell you about what markets expect in the future.

As the Journal's Mackintosh implies, asset prices may be in a bit of a sweet spot. While the pandemic is not over, the widespread distribution of vaccines suggests it could be soon. The Conference Board of Canada and Tiff Macklem at Canada's central bank expect the economy to grow strongly this year and next.

Looking for a soft landing

As Macklem insisted in his most recent monetary policy news conference, even a strong recovery will take years to use up Canada's available surplus of workers and industrial capacity. That means the economy can continue to grow without triggering inflation or an interest rate hike.

In the U.S., the Federal Reserve has also said repeatedly that interest rates will stay near zero at least until the end of 2023.

Some economists worry a rise in rates would make heavy borrowing commitments for such things as mortgages and business loans unaffordable, putting a sudden break on rising asset prices, such as those for houses and stocks.

The debate, and where many economic thinkers diverge from Musk, is where markets are heading in the longer term. Can they keep rising like a SpaceX rocket ship? Can they settle gently to Earth? Or must they return in a ball of flames?

In examining the Canadian housing market, another asset driven repeatedly to new highs by rock bottom interest rates, Canadian real estate economist John Pasalis expects home prices will continue to surge this year. And while governments and central banks must realize what they are doing — stimulating the real estate economy and making Canadian homeowners feel rich — there must eventually be a reckoning, he said.

"I do agree that kicking the can down the road is actually a terrible plan and that the higher prices continue to rise, the harder the fall," tweeted Pasalis, a broker and research analyst who runs his own company.

Following Monday's new market records and Musk's investment in bitcoin, a similar view has been widely expressed by many other market analysts.

In fact, for practical investors who believe that a stock's value depends on future earnings, not speculation, Musk's big move into bitcoin is seen as a move away from value based on earnings. Many conventional financial analysts see bitcoin, with its wild ups and downs and no clear intrinsic value, as not just optimistic speculation but gambling.

Nobel Prize-winning economist Robert Shiller, who published the book Irrational Exuberance just before the dot-com crash of the early 2000s, reminds us to shop around for market advice. (Michelle McLoughlin/Reuters)

"Given that he also runs a corporation seeking to explore or colonize Mars, an investment in cryptocurrency seems almost mundane," a skeptical John Coffee, a former adviser to the New York Stock Exchange, told the Financial Times. "Who knows, maybe Martians will accept bitcoin?"

As with soaring bitcoin, the question Canadian investors may want to ask first is how high markets can go. At what point does Musk's rational exuberance, founded on low interest rates and large government spending and his confidence that the sky's the limit, become irrational?

That is a question directly addressed by the book Irrational Exuberance, written by Nobel Prize-winning economist Robert Shiller at the peak of the dom-com boom before markets tumbled and then reissued just before the U.S. property crash that led to the Great Recession. Much of his advice still holds today, including the following tidbit:

"Certainly some researchers are thinking more realistically about the market's prospects and reaching better-informed positions on its future, but these are not the names that grab the headlines and thus influence public attitudes."

Follow Don Pittis on Twitter @don_pittis

ABOUT THE AUTHOR

Don Pittis

Business columnist

Don Pittis was a forest firefighter, and a ranger in Canada's High Arctic islands. After moving into journalism, he was principal business reporter for Radio Television Hong Kong before the handover to China. He has produced and reported for the CBC in Saskatchewan and Toronto and the BBC in London. He is currently senior producer at CBC's business unit.

now