"What should I do with my cash?" is something I am now asked every day. Peculiar things can happen in a world where cash is more plentiful than investment opportunities. Former U.S. Federal Reserve chair Ben Bernankehas noted that expectations of zero interest rates in perpetuity would make flattening the Rocky Mountains to save train fuel a sensible project. In other news, China will invest billions in its New Silk Road initiative, and is even considering building a tunnel under Mount Everest.
The China experience suggests both good and bad news for global investors. On the one hand, a cash surplus lifts asset prices — as seen in the Chinese property and equity markets. But financial logic also dictates that asset prices cannot decouple from the growth of the global economy forever. Investments eventually need to be justified by profits. Either new investment must accelerate, or investors will have to brace for a period of low returns. We must prepare for either possibility.
If developed market central banks repeatedly resort to their old habit of loose monetary policy every time growth sputters, then asset prices will very likely go on rising. Unless underlying economic growth catches up with asset price rises, however, we will likely see an increase in financial market speculation. Meanwhile, industries geared to rising asset prices will swell to represent ever-larger shares of the economy. The greater concentration of wealth that this implies will limit the scope for a broad-based increase in consumption.
Under this scenario, market valuations would go on climbing, raising questions about financial stability. Central banks might then consider using macro prudential measures to deflate asset prices – increasing the risks of a classic boom-bust story.
I don't think we're far enough down the road of high valuations and speculation yet to raise real concerns about stability. Equities are not cheap, on more than 17 times trailing earnings in the euro zone and the U.S., but are hardly in bubble territory. Many investors I speak to also still have significant cash allocations, suggesting we are not in a period of "irrational exuberance," at a global level at least. And it is difficult to bet against the central banks, especially when they are not constrained by rising inflation. However, if we continue down this path and see risks emerging, we have to be ready to exit risky assets.
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I think the key to a more sustainable path forward for the developed world is higher rates of investment. With real interest rates close to zero for many companies, a new project only has to be able to keep pace with inflation to make sense from a net present value perspective. And corporate leverage is modest, averaging 1.4 times net debt-to-earnings before interest, taxes, depreciation, and amortization (Ebitda) in the Eurozone and 1.3 times in the US.
Higher rates of investment would help restore balance in an investor-friendly fashion. Companies could take advantage of rock-bottom borrowing costs to increase capital spending, and issue equity if they feel their stock prices are above fair value. The greater supply of financial securities would moderate the rise in asset prices, while lifting economic growth and boosting corporate and personal incomes. This in turn would fuel consumption, a critical growth engine which has so far failed to fire up. Finally, a strong economy would enable central banks to withdraw from stimulus programs and steadily raise interest rates, improving the prospects for long-term financial asset returns.
Today's interest-rate policies might represent a once-in-a-generation opportunity to build the roads, bridges, and ports for the decades ahead. It would be a shame if all the policies do is blow a bubble.
Commentary by Mark Haefele, global chief investment officer at UBS Wealth Management, overseeing the investment strategy for $2 trillion in invested assets. Follow UBS on Twitter @UBSamericas.