HAMISH MCRAE: When US bubble pops, watch out!


HAMISH MCRAE: We will get caught in the backwash when the money taps are turned off and the US financial bubble pops

There is a huge boom in asset prices, particularly in the US. And there is the prospect, once we escape from lockdown, of a huge burst of economic growth. 

There is a link, but it is tenuous, for the first phenomenon is a financial story while the second is an economic one. While finance and economics are bound together in the long run, they sometimes move in strange directions. 

The boom in US asset prices is becoming profoundly worrying. Great if you own Tesla shares or have a few Bitcoin lurking on your computer. But we all know that financial bubbles sooner or later burst. They always have in the past, and they always will in the future. What we cannot know is when this one will pop. 

Looking ahead: Solid economic growth and solid company profits will underpin the value of sound enterprises on both sides of the Atlantic

However, since it is pretty obvious that this one has been inflated by free money – the zillions of dollars and other currencies created by the central banks – the warning signals will come when the money taps start to be turned off. The force that will prompt the banks to turn off those taps and put up interest rates will be inflation. 

Already in the US there are signs of that starting to come through. One bit of evidence: oil prices are just about back to pre-Covid levels. Think what will happen to energy demand when the world is allowed to travel again. But things always take longer to happen than people expect. 

So that moment when everyone suddenly realises that prices have got out of hand and are going to crash may be some way off. (If you are interested, the best book on this is Manias, Panics, And Crashes, by the US economist Charles Kindleberger. It is good, if scary, stuff.) 

Here in the UK we have not had a mania on anything like the scale of the US, largely because we do not have a large high-tech sector. That is one of the reasons why UK shares have lagged behind US ones. 

The S&P 500 index is around its all-time high while the FTSE100 has partially recovered from the collapse a year ago, though it is only where it was in the spring of 2013. However, it would be naive to think that as and when the US bubble pops, we will not get caught in some of the backwash. 

But there is going to be an economic rebound, isn’t there? Andy Haldane, chief economist at the Bank of England, has described the economy as ‘poised like a coiled spring’. 

He believes when it is released ‘the recovery should be one to remember after a year to forget’.

I am sure he is right, which incidentally is a good reason for the Chancellor not to make any big tax decisions in the Budget on March 3. 

We don’t know what will happen to the nation’s finances until that coiled spring is unleashed. Better to wait until the numbers are clearer. The best way of closing the budget deficit will be the revenues from rapid growth. 

One question this probability of a sharp economic rebound raises is what does this do for UK share prices? Companies will be growing well, improving earnings, and able to rebuild dividends. That would surely underpin current valuations, and maybe enable share prices to escape the range they are stuck in at the moment. 

So there is the link between the financial story and the economic one. When central banks start raising interest rates the bubble will pop, and I’m afraid a lot of inexperienced investors will lose money. 

But not all prices will fall, or at least they won’t collapse. Solid economic growth and solid company profits will underpin the value of sound enterprises on both sides of the Atlantic. 

We will not escape unscathed from the popping of the bubble. I am a bit worried about what happens to UK house prices when interest rates rise. 

But it will be more like the end of the dotcom boom at the beginning of 2000 than the misery that followed the banking crash of 2008-09 – a difficult few months, but solid growth thereafter.

There is always a dilemma for investors at a time like this, when FOMO (fear of missing out) clashes with our innate caution. 

It is particularly difficult now for three reasons. There is the contrast between the still dismal headlines and the fizzy news of some new high for Bitcoin or a new ‘unicorn’ flotation. There is the fact that a lot of people (not all) have spare cash having been unable to spend in the usual way. And many of us have time on our hands since we can’t go out and have fun. 

That makes it all the more important to remember the two primary rules of investment: spread risk, and allow compound interest to build wealth over the long term.

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