Why are all the wise guys that insist that most of the world’s stock markets, but Wall Street most of all, urgently need a correction for their longer term health, consistently being proved wrong in their forecasts that a market turn is imminent? After all, most of them have been saying the same thing for at least two years, and imminent and the next two years just don’t go together. One answer could be asset inflation. The inflationary excesses triggered in the early 1970s in the US and Europe have finally been exhausted and consumer inflation is no longer a problem, no matter what central bankers may say – and you only have to walk up your high street to be persuaded of this. For most retailers, sales have become permanent features of their doing business, and every time they or their suppliers try to put their prices up, their customers go on strike and tell themselves they will wait until the next sale when they will be able to buy whatever it is they want at the price they are prepared to pay. Yet monetary conditions are lax, bankers are stuffed with cash, interest rates are low by comparison with the experience of the past two decades, so all the conditions are in place for a nasty new dose of inflation. And it is happening – but it’s just not happening on the high street or at the factory gate, nor even in the housing market, where many terribly badly burned fingers have still not healed. But it has to go somewhere, and so it is going into financial assets. Such a scenario explains why shares on Wall Street look so dangerously overvalued, and why, whenever the market takes a little dip, in a mirror image of the case on the high street, buyers rush in and push prices right back up again.
By Tim Palmer
And so long as share prices remain so high, they represent real value for their holders, who can sell a few and go out and turn the proceeds into school fees, new cars or three-piece suites. Until, that is, everyone tries to cash in at the same time, at which point prices will plummet, and what looked like solid value will prove evanescent as gossamer. Asset inflation is the reason that fundamentals are routinely shrugged off and shares rise far beyond any level justified by measures like price-earnings ratios, yield curves or realistic prospects for the underlying businesses – and why the market is so unforgiving to any single counter when it dares to inject a dose of reality into what is a thoroughly unrealistic picture, as has been happening with 3Com Corp. So in this unfamiliar set of circumstances, what is likely to be the trigger that brings the whole edifice crashing down? After all, up to now, the markets have treated bad news as good news, because it meant that interest rate rises would be postponed, maintaining the flow of cheap money into equities. The answer is likely to be central bankers insisting on fighting the last war and finally getting their way over their perceived danger of consumer inflation, putting in place the credit squeeze that will at last put a crimp in the supply of funds to continue to inflate share prices. Then, when the market next dips, there will be no rush of buyers to reverse the fall, the market will slip further, and the long-forecast panic in the markets ensue. The message for individuals has to be the same as it would be to someone suddenly awarded a vastly inflated salary in an industry rejoicing in unsustainable boom conditions: carpe diem, but don’t adopt a lifestyle in line with the salary, because it ain’t going to last.
