This week, we just got through hearing from a bunch of hedge fund managers about how wildly distorted all of the markets were these days because of the Federal Reserve’s Quantitative Easing.
Numerous veteran investors are telling people that they’d be “insane” to buy long term bonds with such ultra-low yields.
Meanwhile, stocks are hitting new highs, so the people who cry “bubble” are out in full force.
In his NYT column today, Paul Krugman takes on the bubble-callers, and says there’s no evidence of a bubble in either stocks or bonds.
First on bonds, he notes that long-term interest rates are primarily a function of the expected path of short-term interest rates. Since inflation is very low by historical standards, and unemployment is still elevated, it makes a lot of sense to presume that the Fed will not be raising rates for a very long time still. Sure they might end QE before too long, but a rate hike is far off in the future. And a substantial rate hike is very far off. Quite simply, bonds look totally reasonably priced given basic assumptions.
As for stocks, there’s not much to see here either.
O.K., what about stocks? Major stock indexes are now higher than they were at the end of the 1990s, which can sound ominous. It sounds a lot less ominous, however, when you learn that corporate profits — which are, after all, what stocks are shares in — are more than two-and-a-half times higher than they were when the 1990s bubble burst. Also, with bond yields so low, you would expect investors to move into stocks, driving their prices higher.
A lot of this is political, or at least ideological. The big hedge fund managers talking about distorted markets are unhappy about Bernanke and the various efforts to revive the economy, a phenomenon we discussed here. This leads them to make a lot of silly calls about how distorted everything is, when in reality there just isn’t any evidence for that.