Deutsche Bank Warns “Markets Seem To Have Entered Frothy Territory (If Not Being In A Bubble)”

Jon Economy

Another day, another warning of market froth, only this time not from the (widely ignored) Federal Reserve, but from Mikihiro Matsuoka, chief economist at Deutsche Bank who in a note released on Monday says that he believes that “the equity market in developed countries begins to show symptoms of ‘froth’. A simple average of the standard deviation of the stock market capitalization as percentage of GDP of seven major developed countries has been approaching very close to the previous peaks of 2000 and 2008. The reason we believe it is entering a frothy territory is that an eventual turnaround of monetary policy after a long period of post-GFC accommodation is under way in major developed countries, which in our view, raises the returns on safe assets and lowers the valuation of risk assets.”
While Matsuoka hardly says anything Janet Yellen did not cover in the past two weeks, here is the summary:
Some factors, such as 1) higher nominal GDP growth above long-term bond yield thanks to massive monetary accommodation, 2) chimera equities in which dividend yields get higher than the long-term bond yield and a resulting rise in P/E thanks to ‘search for yield’, and 3) financial surplus of non-financial businesses in developed countries, might help evade or put off a large and prolonged adjustment in asset prices.
However, the gap between nominal GDP growth and the long-term bond yield has expanded to a historical high under which monetary policy turnaround would naturally shrink the gap. The decline in the potential growth in the post-GFC era eventually restrains the profit growth and a resulting dividend growth over the long run. The price-earnings ratio has been on a slow but persistent rise after the GFC. The monetary policy turnaround could counter this by lowering the valuation of the risk assets. An expanding financial surplus for non-financial businesses reflects disappearance of investment (or profit) opportunities, i.e. an end of capitalism. The fall in the potential growth restrains a rise in the valuation of risk assets over the longrun.

This post was published at Zero Hedge on Jul 10, 2017.