YOUR MIND ON MONEY: Bubbles are hard to detect

2013-11-21T10:31:00Z 2013-11-21T17:32:27Z YOUR MIND ON MONEY: Bubbles are hard to detectF. Marc Ruiz Times Business Columnist
November 21, 2013 10:31 am  • 

The S&P 500 index of stocks traded briefly above the psychologically significant level of 1,800 this week.

This level marks an all-time high for the index, and this action was mirrored in the Dow Jones Industrial Average as the Dow traded above 16,000 and closed at record levels this week as well.

New highs are always exciting for investors, and when these highs coincide with such emotionally satisfying, headline grabbing round numbers, the effects are even more enticing.

While stocks were busy making history on Wall Street, other records were being set across town at Christie’s auction house where a 1969 Frances Bacon painting sold for a whopping $142.4 million.

I can at least appreciate the inspiration propelling stocks higher. The third quarter corporate earnings season has been solid, not great but solid. Job creation in October surged to a much higher than expected 204,000, and retail sales also came in much higher than expected posting a 0.4 percent growth rate. All this positive data occurred despite the supposedly dreadful government shutdown (I’m still mad they closed our parks) and appear to reflect an economy gaining real traction.

The art sale, however, has me taking pause. Now admittedly most of the art in my life involves some sort of snowy wildlife scene, but I’ve learned over the past decade to not view any data point in isolation. After all, it was those investors in 2007 able to connect declining home prices in various overheated local markets to potential risks to the financial system as a whole who were able to dodge the bullet of the decade.

So while these events may have nothing to do with each other, it certainly can’t hurt to use more holistic logic when making investment decisions in the post 2008 world.

The cord that may connect these two headlines is the unparalleled level of liquidity present in this economy. After five years of Federal Reserve policies such as super low short-term interest rates and continuous aggressive economic stimulus in the form of the bond buying quantitative easing program, the Fed may be getting what it bargained for.

These policies are intended to increase the level of money and credit available in the economy with the hope this expanded supply of money will stimulate consumption and real world investment resulting in lower unemployment. But these stimulus strategies are blunt tools, and a real risk of using them is that this liquidity can be potentially misdirected, creating price bubbles in undesired places.

The really tough thing about bubbles is they are extremely hard to detect while you are inside one. This being said, I’m not ready to logically say stock prices are in bubble territory, but I’m putting more confidence in my gut when something doesn’t make sense. And while I’m no expert, the art auction has me scratching my head.

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