Reason to be cautious?

In Uncategorized on 05/11/2010 at 5:23 am

Markets are bullish because of the Fed’s US$600m quantative easing programme. It’s supposedly gd for all asset classes. FT’s Lex urges caution

Take bonds. As Smithers & Co points out, buying bonds while spurring inflation raises the price of bonds while lowering their real value – the definition of a bubble. And bonds look ludicrously overvalued already: for long-dated Treasuries to match their historic real annual return of 3 per cent requires inflation to average less than 1 per cent for the next 30 years.

US equity prices are also more than twice the level long term cyclically adjusted price-to-earnings ratios say they should be. Record high corporate profit margins (and budget deficit cuts down the road that must be funded via private sector cash flows) suggest such a premium is indefensible.

Perhaps the biggest potential wrong call, is whether the Fed should even be trying to raise inflation. Because the US is growing less quickly than the emerging world, its real exchange rate should be declining. Relatively low US inflation is an efficient way to do that. The Fed clearly disagrees. Investors betting the same way are risking more than their portfolios.

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