Tuesday, October 12, 2010

On the Lookout for Asset Bubbles

QE2 is in the air, and lately the thought of it has certain markets all lathered up (or down). Risk assets have caught a bid on the dollar tanking. The inverse dollar trade has propelled returns in commodities and emerging market stocks, which have been rising fast on the back of a more highly liquid world and the belief that growth rates abroad can decouple from the sagging developed world.

The ultimate impact of a QE2 operation is very cloudy, and there are good reasons to be skeptical that it may not be the magic elixir to fix structural problems in our economy. But even if it doesn’t have an economic impact, the extra liquidity may find a home in asset prices, and perhaps even inflate another bubble or two.

Gold and emerging market equities are two asset classes that smell like they could have the makings of a bubble. Bubbles are awful when they burst, but fortunes are made for those that can find early developing bubbles, ride the major portion of the gains, and get out before they pop and wreak havoc on returns.

On the subject of QE2, we are skeptical that it can jump start the economy, but we are also aware that it may just be creating asset bubbles and manias in select sectors and asset classes. What inning are we in? Is it too late invest? Now that’s the making of an entirely different blog.