INSIGHTS

On March 23, 2015

AAM Viewpoints - The Relationship of Suds and Bubbles

The proliferation of news, information, opinion and fact (which all come across in the same way) has had an overwhelming effect on the common investor and the instructional as well. Attempting to delineate the crowded trade from the minority viewpoint is a far greater task currently. Though this increased dissemination of information is beyond the recognition of the investor’s psyche, it does have a more pronounced positive impact. It often deflates bubbles before they become problematic and in its place, creates a collaboration of suds – or micro bubbles. In psychology, there is an acronym for SUDS – Subjective Units of Distress Scale – where one places subjective assessments of relative distress and assists in observers evaluating the level of distress. Sometimes coincidences are just too congruent not to mention. The evaluation of suds to bubbles can be further explained by the following scenarios:

In the Bank of America Merrill Lynch global fund manager survey, we noted that the anxiety of the run up in the U.S. equity markets relative to their global counterparts saw a dramatic shift to under-owned of U.S. equities from slight overweight. This is at a time when – at least on trailing data – the United States is the far better economic performer and would, under past conditions, have warranted a potential over exuberance. Over exuberance has always been a mainstay of classic market bubble bursting. Further affirmation is the continuation of these same fund managers holding over 4.5% in cash, which has historically been a bullish signal for global equities. This has been pinging a bullish signal as this level of cash has been maintained for over 14 months straight and convincingly states the fund managers’ concern for euphoria and appreciation for doomsday prepping.

China, which has been focused significantly on deleveraging the non-performing loan and reducing the shadow banking concerns, has now shifted to stimulus mode. They have reduced their long-term growth plans from 7.50% to 7.00%, which is more in line with expectations from most rational investors. By cutting their interest rates to battle the appreciation of the U.S. dollar, the PBoC (People’s Bank of China) is clearly looking to promote growth. A more significant, but less publicized, measure has been the approval from the Minister of Finance approving a 1 trillion renminbi to assist in the 1 trillion shadow banking debt maturing this year. Though this is a pittance of the estimated 17 trillion renminbi shadow banking total loan, it offers a reprieve this year as the Chinese government attempts to squash the deflationary and growth concern before it becomes a much bigger issue. One side note, there is an increasing amount of chatter that the devaluation of the renminbi may be closer to a reality than anyone has expected. It seems the push to a more domestic consumption focus will be a longer transition than they desire as devaluation further entrenches the export-focused model for China.

The European Central Bank (ECB) has now increased the growth rate for the Eurozone economy from 1.0% to 1.50% for 2015. This is on the implementation of the quantitative easing program which will purchase net issuance of 240%, so long as the bonds being purchased are not yielding below negative 20 basis points…because, a gentleman has to have his standards. Considering over 30% of European sovereign bonds are yielding negative yields, this is the one place where battling deflation could actually cause a bubble bursting if an even below-average economic growth takes hold. The only component that may offset a large amount of liquidation of low yielding sovereign bonds in a growth environment would be a reversal of the decline in the euro to a strong appreciation trend.

The psychology of investors and the confidence in the system has been “semi-permanently” altered from the amount of equity corrections, housing corrections and dysfunction in the political system. The byproduct is measured in the Fed Flow of Funds which showed the net worth and total deposits for households increasing yet again. Net worth grew north of 5% over 2014, below the long-term average of 7%, while total deposits continued to grow to $10.2 trillion.

The challenge is that the immense amount of liquidity seen currently often mitigates the short-term manufacturing of bubbles, but ultimately leads to a proliferation of them as herd mentalities take hold. For this to take root, we would need to see an incredible amount of herding toward the same trade. That just isn’t quite the case yet. The anemic yield and global debt consternation is the most problematic and imminent, yet as the Fed relayed last week, even with “patient” being removed from their verbiage, they are still going to be data driven. When suds become bubbles, it is best to make your way toward the exits and say your goodbyes quietly. 

CRN: 2015-0319-4655R

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