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Jeff Meli Ajay Rajadhyaksha

Episode 33

Jeff Meli in conversation with Ajay Rajadhyaksha

Are financial assets headed into bubble territory?

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Lately, a common question investors are asking is, “Is this becoming a bubble?” With ultra-accommodative monetary policy, soaring stock prices and plenty of unusual macroeconomic factors in play, the possible presence of bubbles – at both an individual asset and broader market level – has become a recurring concern.

In episode 33 of The Flip Side podcast series, Head of Research Jeff Meli and Head of Macro Research Ajay Rajadhyaksha debate whether bubbles are present and, if so, which ones pose the greatest systemic risks versus those that are smaller and short-lived, ranging from bitcoin to the wider stock and bond markets.

  • Jeff Meli: Welcome to this episode of The Flip Side. I'm Jeff Meli, the Head of Research at Barclays and I'm joined today by Ajay Rajadhyaksha, our Head of Macro Research. Thanks for joining me, Ajay.

    Ajay Rajadhyaksha: Thanks for having me, Jeff.

    Jeff Meli: On our last episode, we spoke about the run-up in some stocks that was caused by concentrated buying from retail investors who are loosely coordinated on social media platforms like Reddit. The volatility in some of those stocks has continued but we want to take a step back and look even broader in this episode and talk about the risk that some, or even many or most asset prices, have reached bubble territory.

    Ajay Rajadhyaksha: OK. So, that notion, that broader categories of financial assets are bubbles, does still seem far-fetched to me. I do think investors should be worried about bubbles but not the relatively small short-lived ones that you focus on in the last episode. But instead, some specific bubbles and some assets that are now so large, that they cannot be ignored.

    There are extreme versions of the so-called "meme stories" and investors have pushed those prices well about fair market value. The ones to be worried about have really big market gap and are moving into major industries, are becoming more common investments and they will be the ones that cause major losses once valuations come back to reality.

    Jeff Meli: Well, Ajay, I was about to say the exact opposite. I think we get way too worked up about some high-profile individual assets, most of whose valuations I think I could justify. I think the bubbles we're supposed to be worried about are actually market-wide. I think the recent tremors that we saw in the equity market associated with higher interest rates demonstrates just how reliant we've become on ultra-accommodative monetary policy. I think popping that bubble would have some major economic implications.

    Ajay Rajadhyaksha: Well, look, the examples you spoke about in the last episode, right, they're very relatively small-sized assets and those prices we know increase sharply because they became favorites on social media platforms like Reddit.

    This was short term, small phenomena; it can be safely ignored by most investors. What I'm saying is there are other bubbles that cannot be ignored. They are large enough, they are important enough that investors need to be aware of the risks that they pose and I'll give you two examples, Jeff, Tesla and Bitcoin.

    Jeff Meli: OK. At least to Tesla, I agree that investors need to pay attention to it. It's now in the S&P 500, so basically, anybody who ones an index fund owns some Tesla. I'm less convinced why anyone would really need to care about Bitcoin.

    Ajay Rajadhyaksha: Because of it's market cap. Bitcoin is now close to a trillion dollars in market cap. That's about Tesla, which is really big, but it still has $600-700 billion, well below Bitcoin. And remember, all of crypto is worth $1.5 trillion. That's the size of the U.S. high-yield market.

    And we definitely tell investors that they should care about high-yield bonds or leveraged loans. There's also a potential that we see some new products that facilitate even more broad-based investment and cryptocurrencies like exchange rated funds. These are asset classes that we need to care about.

    Jeff Meli: Now, there's a difference between these two examples you just cited. Tesla is a traditional financial asset. It's a stock. Its price is dependent on future cash flows and one could debate or try to estimate what those are going to be. I'm not sure how traditional asset pricing even applies to Bitcoin.

    Ajay Rajadhyaksha: Well, that is part of my point. But let's stick with Tesla for a minute. It's definitely a meme stock as shown in the recent note we put on the linkage between Reddit posts and Tesla price action. It's also a stock that's very difficult to short. You have a founder/owner that is very vocal on social media, very opposed to short-sellers, and there's an extreme valuation.

    Just for context, Tesla is priced around the total market cap of all of the other auto manufacturers combined.

    Jeff Meli: Ajay, transformational technologies are often underappreciated. You could look at Amazon as an example. It went from bookseller online to being the biggest provider of cloud computing. And for a few years, no one had any idea that they were the world leader in an industry that was going to have 30-40 percent profit margins. They were just quietly investing in new businesses.

    Ajay Rajadhyaksha: Yes. But I could have come up with as many examples on the other side, where the early adopter just fades away. Look at Yahoo!, Netscape, AOL. And speaking of things that could fade away, let's talk about Bitcoin for a minute.

    The price has gone from about $10,000 over the summer to a peak near $60K. This is a, quote-unquote, "asset" which regenerates no cash flows; it is not backed by any government. It's the ultimate meme stock. Now, that's sounds like a bubble to me.

    Jeff Meli: Economists think of three characteristics of money. Money is supposed to be a store of value. It's a unit of account and it's a medium of exchange. I'm not sure how Bitcoin differs from any other examples of fiat money that's issued by government on these three metrics. So, why do we care if it's backed by a government or not?

    Ajay Rajadhyaksha: Well, look, fiat money has value because it can be used to pay taxes. Your government insists on receiving payment in a specific form. I think that form is a backdrop under which currency does have value.

    Jeff Meli: What you're saying is true for developed markets, I think, but there are lots of emerging market currencies that you can use to pay taxes too, but they're a lot less dependable than Bitcoin. You could look at the currencies of Venezuela, Turkey, the rand in South Africa, they've been extraordinarily volatile, have lost huge amounts of value.

    Bitcoin has been a much better store of value than those currencies. It would seem to me that – that really, the element here that's key is trust. You need to believe that your currency, whatever it be, be it fiat issued by a government or Bitcoins, is going to have value in the future. As long as the Bitcoin holders maintain that belief, I don't see why the – what whatever value they'd put on, it isn't sustainable.

    Interestingly, here is no chance of dilution which helps with the trust. So, for Bitcoin, there's no chance that government is getting issue a whole bunch more of it. It's algorithmically determined to supply a Bitcoin and the new supply goes down every year.

    So, there's no cash flows, like you mentioned. There's no future date whereby Bitcoin could be proven to be worthless. Unlike Tesla, the value of Bitcoin can never really be proven wrong.

    Ajay Rajadhyaksha: Yes, maybe not. But you can lose your password and then it's gone forever. I've seen estimates of as high as 15 percent of the coins out there being locked up including one example of a guy who had $250 million worth that he can't get at.

    Now, the store of value argument. Sure, the price is high right now, but Bitcoin is shockingly volatile. Very similar to some of those risky EM currencies. It just happens to be on an upward tear now. Remember, it lost almost 20 percent of its value in a week, not so long ago, when yields rose sharply. That doesn't sound like a great store of value to me.

    Jeff Meli: Ajay, overall, I think your focus here is too narrow. Tesla and Bitcoin, other assets that are similar to those, they're large, sure in terms of market cap, but I think they're a sideshow.

    I think the real issue here which you hinted at regarding the sensitivity to interest rates is that ultra-accommodative monetary policy, which includes low interest rates but also large asset purchases by central banks, have forced investors to bid up financial assets across the board.

    I think you could argue the whole stock market, the whole bond market, are both bubbles. Those are big markets. They're priced to reap the benefits of massive fiscal and monetary stimulus, but suffer no increase in inflation. That's what I call being priced to perfection.

    Ajay Rajadhyaksha: OK. You are at least thinking much bigger than me. I was talking about a couple of trillion-dollar assets, you were talking about tens of trillions being mispriced.

    Jeff Meli: Well, first, Ajay, I think it's quite clear that valuations across financial assets are extremely dependent on accommodative monetary policy. You could see the linkages in the recent seven-year treasury auction which fared very poorly.

    Very quickly you had bond markets across the board, really globally, sell off in response to that and then that turned into a rout in the stock market. So, we had financial assets across the board selling off due to a – due to a modest uptick in one part of the treasury yield curve. And that was after Chairman Powell of the U.S. Federal Reserve spent two days assuring Congress at the Fed would stay super easy for a long time.

    Ajay Rajadhyaksha: OK. It is true. You're right. Bond yields have risen and you pointed to one shot move, but really, the trend has been higher rates since the start of the year. But they are rising because things are working, because policy support is in place, because we've had good COVID news, and as a result, the growth outlook of the U.S. and the world is stronger.

    COVID cases are falling off a cliff. The U.S. is setting a rapid pace of vaccinations. The expected fiscal impulse heading the U.S. economy has jumped massively in the last two months. We already announced $935 million in late December. We might get another $1.9 trillion now and perhaps $2 trillion in trust which are stimulus at the end of this year. This is all good news for growth and we shouldn't be worried about it coming with slightly higher rates.

    Jeff Meli: If growth is improving, Ajay, then why did stocks sell off just as bond yield started to rise?

    Ajay Rajadhyaksha: Yes. But come one, look at how short-lived that was, Jeff. Stocks came back strongly the next Monday, far more so than bonds did.

    Jeff Meli: I think the Fed talking down expectations of future rate hikes probably helped with that recovery. But I still think we learned a lesson about how dependent we are that that accommodative stance stands. And I'm worried that the Fed's hand is going to be forced.

    Now, we've been waiting for inflation for years, really over a decade, since the global financial crisis and I think were actually about to get it. So, all that stimulus that you just mentioned really doesn't have any place to go in the economy.

    One of the major economic effects of the pandemic has been reduced supply. That means that the capacity of the economy is lower, primarily because so many people are out of the workforce. As we add more stimulus, we really quickly get to supply chain snarls, pushes up goods prices.

    We're almost sure to see a steady increase in the inflation data for the next six months and that becomes very self-reinforcing if it – expectations of future inflation start to rise too.

    Ajay Rajadhyaksha: Now, hold on inflation is rising partly because of base year comparisons. The second quarter of last year was very deflationary. To get sustained inflation in a western economy, you need sustained wage growth.

    Remember, 10 million people are still unemployed in the U.S. relative to last February and itwill be a while before that changes. That's where the stimulus is an outlet. In fact, market expectations of medium-term inflation are right where they were at the start of the year.

    Bond sold off about a week or so ago because real rates rose and that was the markets way of pricing in not stronger inflation, but a stronger growth outlook.

    Jeff Meli: You know, Ajay, it's not just the stimulus, because like you mentioned the COVID news is pretty good too and the chance that the U.S. economy reopens for real is actually becoming a real possibility. Add to that, the that U.S. households have saved a substantial amount of money over the pandemic.

    And our economics team just wrote about what they think is going to happen to all that money once we reopen and they believe that a lot of it is going to get spent. Really, the stimulus is just gas on the fire. We're about to have the mother of all recoveries. We expect U.S. growth to be reasonably above 6 percent this year. Isn't it hard to justify a one and a half percent 10-year Treasury yield? Doesn't that sound like a bubble to you?

    And once the Fed is forced to move, I think we will look back on this recent episode of higher rates as being the canary in the coal mine.

    Ajay Rajadhyaksha: OK. Six-point-four percent, our official GDP forecast, that is a very strong year. But you are coming off a deep recession last year. And you know, look at the Trump backsteps as an example of how all of these pieces fit together.

    Remember, at that point also, a lot of people thought cutting taxes at the height of the economic cycle would lead to all of this issues you are worried about now, overstimulating the economy. And instead, what did we see? We saw the jobless rate fall far below where most of us thought it was possible.

    These folks who were employed 12, 18, 24 months old, they will come back to the labor force as we start reopen and with at least near, Jeff, to get back to those employment levels before we have to worry about the Feds hand being forced on the raising interest rates.

    Ultimately, Jeff, I'm not arguing that if rates do rise because of inflation fears, I'm not saying there won't be an impact on stocks and bonds. But remember, we spent 12 years pre-COVID missing inflation to the downside even as the unemployment rate went down to three-and-a-half percent.

    I just have a hard time seeing fears about inflation rise to the point that stocks and bonds both lose massive amounts of value. And if rates are rising for the right reasons because growth is doing well, I think the impact on the stock market in particular will be limited and I think the bond market unwind will be very, very manageable.

    We are, where we are, because of fundamental reasons, not because the Fed is supporting bubbles.

    Jeff Meli: Well, Ajay, I realize I'm at risk of joining a long list of inflation fearmongers since, like you said, we've been expecting inflation for 12 years and have failed to receive it. But I do think we'd never seen a combination like this before with such massive federal spending and such excess savings built up in the economy.

    But we'll see it play through, particularly as the stimulus package works its way through Congress. Clients of Barclays can read our latest take on how the economy in the U.S. will reopen in, "Excess Household Saving: Framing the Debate," available on Barclays Live.

    Male: That's all for now from this Barclay's podcast. Thanks for listening and we'll catch you next time on The Flipside. For more insights about this topic, clients can log in to Barclays Live or find out more at

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About the analysts

Jeff Meli is Head of Research within the Investment Bank at Barclays. Jeff joined Barclays in 2005 as Head of US Credit Strategy Research. He later became Head of Credit Research. He was most recently Co-Head of FICC Research and Co-Head of Research before being named Head of Research globally. Previously, he worked at Deutsche Bank and JP Morgan, with a focus on structured credit. Jeff has a PhD in Finance from the University of Chicago and an AB in Mathematics from Princeton.

Ajay Rajadhyaksha is Head of Macro Research at Barclays, based in New York. He oversees the global research and strategy efforts of the economics, rates, FX, commodities, emerging markets, securitised, and asset allocation teams. Since joining Barclays in 2005, Ajay has held various positions, including Co-Head of FICC Research and before that, Head of US Fixed Income Research and US and European Securitised Research.

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