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The Fed’s stock market bubble is at risk as China bursts its real estate bubble

Economic growth
By Paul Hodges on 24-Oct-2021

The US stock market bubble just keeps rising. And every investor “knows” that the US Federal Reserve will never let it burst. But the Fed can’t control the fallout from the bursting of China’s ‘subprime on steroids’ real estate bubble.  Could this also mean the end of the Fed’s bubble? 

There is no doubt that stocks are in a bubble, as the chart showing Nobel Prize winner Prof Robert Schiller’s CAPE ratio confirms. It is well above even the 1929 level, and is approaching its all-time 2000 high.

It has also become clear in recent weeks that the Fed’s stimulus policy has enabled Chairman Jay Powell, key Fed Governors and Senators, to add to their fortunes by well-timed trades. This is quite different from the past, when the Fed saw its role as being:

“To take away the punchbowl as the party gets going”.

Investors are very different today, as well.  Very few ever bother to check out a company’s actual results. Instead, the key skill is “Fed-watching”. The real money, after all, is made by “buying on the stock market’s dips”. And, of course, following the “hot stocks” adds to the fun.

In reality, both China and the Fed have effectively tried to ‘print babies’.  The chart highlights the key issue:

  • It shows the ratio between the number of Americans in the high-spending Wealth Creator 25-54 cohort, versus the number in the low-spending Perennials 55+ generation
  • A high ratio means more Wealth Creators, and so more demand and more inflation
  • The famous Boomer generation (1946-64) created a lot of new demand, well ahead of supply, creating 14% inflation as the right axis shows
  • But since 2000, more and more Boomers have been retiring and so inflation rates have come under pressure

The Fed has printed $7tn of stimulus money at 0% interest in its efforts to keep asset prices rising. China went one better, as its vast stimulus actually created vast speculative demand for empty apartments.  It now has enough empty property to house 90m people.  In other words, it has more or less replaced Portugal’s entire housing stock every year, for the past 10 years.

But now China is bursting its real estate bubble, and that demand will simply disappear. So all those countries/companies who built new capacity to supply the bubble, will have no customers.  Instead, they will have “stranded assets”. Nobody else will want to build millions of empty apartments, now China has stopped.

No doubt companies will cut prices to try and stay in business.  But this will only make things worse as prices then start to fall, and we head into deflation – probably sometime next year.

Before long, therefore, investors may find themselves forced to refocus on company earnings again, rather than Fed-watching.

But at the same time, as I noted 2 weeks ago, far-sighted companies will be rebuilding the economy from the bottom up, to meet Net Zero needs.  As the CEO of the Stellantis car company has noted:

“The transformation period is a wonderful opportunity to reset the clock and start a new race”.