Despite easing concerns about Covid, inflating asset values becoming a major worry

Animal spirits in full flow but AUM in money market funds have stopped falling
US stocks continued to rally as market’s animal spirits were in full flow and as retail investors ploughed more money into smaller caps. Meanwhile, stock funds saw yet another record weekly inflow exceeding $50bn. The VIX Volatility Index, better known as ‘the fear gauge’, also fell below its symbolic 20 level for the first time since the pandemic hit a year ago underlining the run-away ‘risk on’ mood of the market. From penny stocks to crypto currencies, from record number SPACs being launched weekly to big moves in IPOs, almost all measures seem to be raising red flags, indicating that asset values are overheating.

Interestingly, however, assets seeking refuge in US money market funds that had surged by over 30% between February to May of 2020, to record highs of $4.8trn at its peak and had been on a gradual downtrend for much of last year, have been moving sideways since December. Indeed, the AUMs there still remain 20% above the February levels when the pandemic first came to light. This is perhaps indicating that despite record stock market levels and growing confidence about the end to the pandemic in H2 of this year, institutional asset allocators are not as comfortable in raising their weighting in risk assets much further from here, at least for now.

Japan asset price bubble of the 80s revisited 
Certainly, among the previous bubbles that had popped which we have seen first-hand, including the tech bubble in the late 90s and credit bubbles of the mid 2000s, none had come as close to resemble the Japan asset price bubble of the late 80s as the one we are witnessing currently in the US. To recount, at that time, the newly appointed BOJ governor, Yasushi Mieno believed that asset price bubbles are morally corrosive to the society and create wealth disparities that could be socially destabilising in the long run and needed to be stamped out. Although in 1990, Japan’s CPI inflation gauge seemed fairly tame, Mieno-san began raising rates to purge Japan’s economy from what he deemed to be the excesses of the past.

Despite bursting of Japan’s bubble which hit our stock market for almost two decades, we have huge respect for Mieno’s vision and policy clarity. Clearly, the late BOJ governor’s concerns about the impact of low interest rates on growing wealth disparity is being played out in the US both in the political arena and economically. However, in the case of the US Federal Reserve of the past two decades, its board seems to have continued to kick the can by ignoring asset price inflation, remaining focused on the core price gauge and its other key mandate of trying to keep the economy operating close to optimal employment. 

We think the US monetary policy of the past two decades has played a key role in widening the wealth gap and creating a liquidity trap which looks to be tough to get out of. With the Biden Administration going even further by appointing another monetary policy dove and the ex-chair, Janet Yelen as the Treasury Secretary, who fully supports throwing the kitchen sink at the pandemic-hit economy to help the recovery, it is difficult to see how the ultra-loose monetary and fiscal policies in the US will reverse course anytime soon, even if we are already seeing worrying signs of inflationary pressures building up across the industry. So, although we remain fairly confident that we will see an end to the pandemic by H2 of this year as we have outlined in our previous publications this year, we are increasingly concerned about economic policy makers ability to engineer a soft-landing given the ever-inflating asset price bubbles we are witnessing.