September 30, 2014

Asset values surge amid central bank stimulus

The value of many assets around the world - including real estate, stocks and bonds - has been rising, and several market participants have warned they have grown inflated and approach bubble status..

Central bank stimulus
Many market participants have pointed to central bank stimulus when explaining why so many asset classes are considered expensive by historical standards, according to a New York Times piece by Neil Irwin. Over the last six years, central banks across the world have been adding trillions of dollars to the money supply and also keeping benchmark interest rates near record lows in their efforts to jumpstart economic growth.

The Federal Reserve has increased its balance sheet to more than $4 trillion in the process. The Fed has been taking part in quantitative easing since late 2012, and these monthly bond purchases are scheduled to finish in October 2014. Even though the central bank has almost completely wound down these transactions, it is still uncertain when the Fed will increase its benchmark rates.

ECB to buy more securities
Alternatively, the European Central Bank has more plans to buy covered bonds and asset-backed securities, and has stated it will provide further detail at the conclusion of its monthly policy meeting happening on Thursday, Oct. 2, Reuters reported. The ECB will purchase 200 billion euros ($252 billion) worth of these financial instruments over the course of a year, according to euro money market traders participating in a Reuters poll.

The region's central bank will start buying covered bonds before purchasing asset-backed securities, since it is easier to trade significant chunks of the former than the latter, according to Bloomberg.

JPMorgan analysts, led by Gareth Davies, wrote in a note to clients that the ECB will have an easier time bolstering its balance sheet with covered bonds, as there are 791 billion euros ($997 billion) of these debt-based securities outstanding, while there are only 251 billion euros ($317 billion) of ABS, the media outlet reported.

Plunging bond yields
Amid these conditions, where investors are looking to snap up whatever assets they can get their hands on and central banks have provided substantial liquidity, bond yields have plunged, according to The New York Times. A perfect example of this trend is Spain, where investors were recently willing to accept the lowest yields since 1789.

This was not an isolated incident, as bond yields across the euro zone fell to record lows in August, The Financial Times reported. On Aug. 14, Germany's benchmark borrowing rates dropped to less than 1 percent for the first time ever. This decline happened after government data showed the country's economy contracted in the second quarter.

In the U.S., bond yields on 10-year Treasury notes have refused to rise above 3 percent, the level they reached at the end of last year, according to The Wall Street Journal. On Monday, Sept. 29, these debt-based securities had a yield of 2.491 percent. They reached their lowest level of the year in August, hitting 2.33 percent.

In addition, Steven Major, global head of fixed-income research at HSBC Holdings plc., predicted earlier this year that the 10-year Treasury's yield would fall to 2.1 percent by the end of 2014, the media outlet reported.

Real estate continues its climb
Real estate prices have been moving steadily higher, and this appreciation can be observed across many different property types, according to The New York Times. Data provided by Real Capital Analytics show that while office space in central business districts costs an average of $147 per square foot in early 2010, it has surged to $300 a square foot since then.

Office buildings in Manhattan have also grown more expensive, as investors looking to purchase one can expect a return of 4.4 percent, after subtracting expenses from rental income, the media outlet reported.

A perfect example of the red-hot state of New York City's real estate market is the Art Deco office tower at One Wall Street, which sold for $585 million earlier this year, only three months after one real estate tip sheet said that BNY Mellon, the seller, expected to generate bids above $466 million.

Stocks reach record highs
Equities have also been climbing, with major stock indices hitting new highs recently, as the S&P 500 Index reached more than 2,012 on Sept. 18, according to CNBC. The Dow Jones Industrial Average reached an intraday high during that day, after increasing 118 points. Then, on Sept. 19, the Dow hit a new closing record, finishing the session at 17,279.74, USA Today reported. During the day, the S&P 500 surged to an intra-day high of 2,019.26.

"We're in a world where there are very few unambiguously cheap assets," Koesterich, whose position consists of searching for strong opportunities where investors can get robust risk-adjusted returns, told the media outlet. "If you ask me to give you the one big bargain out there, I'm not sure there is one."

How financial institutions can benefit
Amid this situation - where many warn that all assets are overvalued - banks should be actively managing their books. If they identify loan portfolios they might want to sell, now is the time to act, as doing so could fetch a compelling value.

If banks are serious about getting the best possible price, they might consider working with Garnet Capital Advisors, which has substantial experience in this space.