I am on the final lap of a series of year-end presentations, press conferences and media interviews. I am struck by the apparent complacency of markets with respect to the euro-zone crisis. But even more so when repeatedly questioned about whether I thought that there was a risk of a bond bubble and the apparent end of “the cult of equity.”
We are in a bond-market bubble for benchmark (Bunds, Treasuries, JGBs and Gilts) bonds. With nations’ respective quantitative easing measures in place now for a number of years, and supported by legislation forcing banks, insurance companies and pension funds to shed risk assets in favour of supposedly less risky (domestic) bonds, yield levels have been compressed to below long-term average inflation—and in most cases below actual and expected inflation—along the entirety of the yield curve.
Markets have been told that central bank action to force the remaining market participants into “riskier assets” would continue until such time as a recovery was firmly in place. This means that the normal adjustment of the yield curve to improvements in economic activity will be delayed, leaving central banks “behind the curve” on purpose.
Much is also being made of the supposed death of the cult of equity, which I have previously commented on. Unfortunately, this statement leads most investors to draw the wrong conclusion, namely that it will no longer be attractive to invest in equities in the future or that equities will no longer earn their risk premium. And after nearly 15 years of outsized returns on fixed-income securities and a sideways equity market, this is perhaps natural.
Moreover, I agree that the fixation on capital appreciation at the expense of dividends, the manifest neglect of sustainability issues—maximizing short-term profit at the expense of the long-term sustainability of the business model—are probably best left six feet under. However, as I have argued before, the capitalist free-market system will not survive without risk assets earning their risk premium—and survive it will. All of these factors add to my moderately bullish sentiment for 2013.
I will return to this topic and the attendant risks to the more positive outlook, including the euro zone, in next month’s official 2013 outlook.