My 25-year-old nephew just landed his first full-time job and wants to start investing. But in what?
The answer would once have been simple. A well diversified portfolio of domestic and international stocks, with a reasonable helping of bonds on the side, could have been counted on to produce decent returns for him in just about any economic environment.
These days, though, none of those options look all that appetizing. After an epic five-year rally, stocks everywhere appear toppy. Bonds offer dismal yields and will be vulnerable if interest rates start rising. Alternatives such as real estate strike many of us as even more expensive.
The New York Times has labelled this the "Everything Boom – and quite possibly, the Everything Bubble." From farmland to office towers, from equities to bonds, from blue-chip North American securities to dicey bets on debt-ridden European countries, assets have been bid up to lofty levels, according to writer Neil Irwin. He cites data that show just about every major class of investment is trading well above its historical norms.
The Bank for International Settlements (BIS), the banker for central banks, agrees. In a report published two weeks ago, it raised alarms about "extraordinarily buoyant financial markets."
There's little mystery about what's behind all of this. Both Mr. Irwin and the BIS point the finger at record-low interest rates and easy money policies that have fuelled a tsunami of speculation around the globe. The only question is whether this amounts to a woeful blunder on the part of policy makers or a clever design feature.
The BIS believes artificially low rates are pushing investors to take increasing risks in pursuit of returns. It sees the Everything Boom as a development dripping with danger.
Others, such as economist Paul Krugman, argue that the rise in asset prices is perfectly logical – so long as you assume that today's low interest rates are a realistic reflection of a world in which the supply of savings is running well ahead of the desire to borrow. If so, low rates that turn cheap assets into expensive ones are an important way to bolster a weak economy by making people wealthier and encouraging them to spend.
Well, maybe. But it's hard to call many assets cheap any more. North American stocks are at record highs; so are Canadian home prices.
Bond prices are verging on the comical all around the world. Iceland, which saw its economy sink into the ocean during the financial crisis, sold €750-million ($1.1-billion) of six-year bonds on Tuesday. Investors snapped them up – despite a paltry yield of 2.6 per cent.
It's natural to wonder how this story will end. Back in the fall of 2011, in its Quarterly Bulletin, the Bank of England published a handy guide to quantitative easing, much of which applies to any easy-money program. It includes a helpful graph that shows real asset prices rising during the so-called "impact" phase – and then plunging back to earth as the economy adjusts.
Right now, we appear to be nearing the end of the impact phase. Low interest rates have boosted asset prices and driven up the price of everything. Unlike previous booms, such as the dot-com bubble, the euphoria isn't restricted to a single sector but runs across all asset classes.
What happens next? If the Bank of England is right, we should start to see inflation pick up, in tandem with GDP growth, while asset prices slide back to more normal levels. In other words, we'll experience a strong economy but weak markets – just the opposite of what we've seen over the past few years.
A stronger economy should help my nephew's career prospects. But it may well be accompanied by a sustained period of low returns for the portfolio he's just beginning. That, at least, is one prospect we should keep in mind as we enjoy the Everything Boom.
Ian McGugan