Executive Summary
- Global fundamental economic conditions are nearly perfect and have been for some time.
- Availability of global credit is generous and cheap and has been for some time.
- Animal spirits and optimism are therefore high and feed on themselves through reinforcing results and through being universally shared.
- All global assets reflect this and are overpriced and show, probably for the first time, a negative return to risk taking.
- The correlation in global economic fundamentals is at a new high, reflected in the steadily increasing correlation in asset price movements.
- Global credit is more extended and more complicated than ever before so that no one is sure where all the increased risk has ended up.
- Every bubble has always burst.
- The bursting of the bubble will be across all countries and all assets, with the probable exception of high grade bonds. Risk premiums in particular will widen. Since no similar global event has occurred before, the stresses to the system are likely to be unexpected. All of this is likely to depress confidence and lower economic activity.
- Naturally the Fed and Fed equivalents overseas will move to contain the economic damage as the Fed did last time after the 2000 break. But the heart of the last bubble, the NASDAQ and internet stocks, still declined by almost 80% and 90%, respectively.
- Of course the tricky bit, as always, is timing. Most bubbles, like internet stocks and Japanese land, go through an exponential phase before breaking, usually short in time but dramatic in extent. My colleagues suggest that this global bubble has not yet had this phase and perhaps they are right. In which case, pessimists or conservatives will take considerably more pain. Again?!
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