Feeding the Bubble: Is the Next Crash Brewing?

By Martin Hesse and

Twitter executives and founders at the New York Stock Exchange on Nov. 7 clap as their company launches its initial public offering. Zoom
DPA

Twitter executives and founders at the New York Stock Exchange on Nov. 7 clap as their company launches its initial public offering.

Central banks around the world are pumping trillions into the economy. The goal is to stimulate growth, but their actions are also driving up prices in the real estate and equities markets. The question is no longer whether there will be a crash, but when.

When 42-year-old hedge fund manager Mark Spitznagel wants to forget about his high-stakes business for a while, he heads to the goat farm he and his wife Amy purchased in the bucolic hills of Michigan. There, he produces cheese according to environmentally sustainable methods, because he views modern agriculture, with its large-scale pesticide use and automated factory farms, as degenerate. In fact, he says, factory farming is "an ideal metaphor" for the economy.

In Spitznagel's view, the world's financial and equities markets are also dysfunctional, and what happens there is unhealthy and anything but sustainable. As a money manager, he has also opted for an alternative business model of sorts: He's betting on a crash.

For his customers, Spitznagel's multi-billion-dollar fund acts as an insurance policy against the next meltdown in the financial system. When the market is doing well, they lose modest amounts of money. But they cash in as soon as prices take a nosedive, even when all other investments are going up in smoke.

The hedge fund manager has made a lot of money in the past with his prognoses, and he is convinced that substantial turbulence is on the cards for the near future. "The setup is there for it," says Spitznagel.

'It Might Go Badly'

Since the last crisis, central banks around the world have pumped trillions into the economic cycle, both by lowering interest rates and buying up securities in the markets. For central bankers like United States Federal Reserve Chairman Ben Bernanke, the aim of the policy was to stimulate the economy and rescue banks that could no longer raise capital elsewhere. But this "grand monetary experiment," as Spitznagel calls it, has side effects. Because it makes borrowing cheaper than even before and saving all but pointless, it encourages investors to pursue reckless deals. Share prices are exploding on stock exchanges around the world, while real estate prices are rising at an alarmingly fast pace. And many US companies are now in as much debt as they were before the financial crisis.

To take Spitznagel's metaphor a step further, the flood of money coming from central bankers acts like a highly aggressive, artificial fertilizer. It generates enormous yields in the short term, but eventually leads to potential devastation.

Graphic: The bloated value of publicly traded companies worldwide Zoom
DER SPIEGEL

Graphic: The bloated value of publicly traded companies worldwide

For this reason, the ongoing party in the stock and real estate markets is beginning to feel uncanny to a growing number of observers. "It might go badly," Nobel laureate Robert Shiller told SPIEGEL. Some economists are even convinced that the question is no longer whether the next crash is coming, but when.

For brokers on the venerable trading floor at the New York Stock Exchange, such predictions are hugely exaggerated. "This is not a bubble," says Peter Tuchman, who has worked on Wall Street for almost 30 years and, with his white, Einstein-like hairstyle, half a dozen bracelets and well-worn running shoes, is a legend on the floor. He taps his smartphone a few times and pulls up a graph depicting the S&P 500 index of stock prices for 500 large companies, which has gone up by 166 percent since it hit rock-bottom in 2009. "This is a stable development," says Tuchman, pointing to the graph, which is directed uniformly upward. In his view, these are simply good times following on the heels of years of crisis. "There are new company listings every day," he says. "That is a good sign to me."

It's the first Thursday in November, the day of the Twitter IPO, and the jocular trader is completely in his element when a nine-year-old girl in a tulle dress and actor Patrick Stewart, who played Captain Jean-Luc Picard on the "Star Trek: The Next Generation" series, ring the traditional opening bell.

At 9:45 a.m., during the initial pricing phase, the Twitter share price jumps from $26 (€19) to more than $40. At 9:54 a.m., Twitter is trading at about $42 a share, and at 10:49 it's at $45.10. "If you bought the stock yesterday evening and sell it today, you'll have earned a return on investment of more than 70 percent," says one of Tuchman's fellow traders, with a note of awe in his voice.

Twitter hasn't made any money yet, nor does it have a convincing idea of how it will do so.

Other tech stocks are also doing extremely well, just as they were in the heyday of the New Economy. Amazon's share price has almost doubled in two years, while electric car manufacturer Tesla has gained 300 percent in market value in the same period.

"It is a complete joke," says hedge fund manager Spitznagel. He explains that the market is driven by investors' confidence that prices will continue to rise in the future. He says it is "a self-reinforcing process entirely disconnected from economic reality."

A Hunger for German Stocks

For many people, what Spitznagel is describing is typically American. In the heartland of capitalism, the crash has been to economic life what the Colt gun was to the Wild West. In Germany, on the other hand, centuries-old family businesses operating in brick-and-mortar factories make sophisticated tools, machines and systems, with which real, palpable, everyday products are made in the rest of the world. One would think that prices would be more down-to-earth in such a grounded environment.

Dürr AG, which makes machine tools in Germany's southwestern Swabia region, is one of those traditional companies. In business since 1895, Dürr is a supplier to automakers, as well as the chemical and aviation industry, and it manufactures production and environment technology systems -- a thoroughly solid product line.

But Dürr's share price has doubled within a year and increased fourfold in the last two years. A share of Dürr stock costs €66 today, whereas it could be had for less than €4 in 2009.

That's because international investors are hungry for securities like Dürr shares, which embody the successful model of Germany's export economy. It's also because companies like Dürr benefit from growth in emerging economies, and because their operations are in Germany and not in one of the crisis-ridden countries of the euro zone.

This demand has driven the MDAX, a German stock index for mid-sized companies, from 11,400 to 16,300 points within a year. The index is currently almost four times as high as it was during the stock market boom in 2000, far outperforming the DAX itself, an index of Germany's 30 largest companies -- although the DAX is also breaking one record after the next.

Germany is a hot commodity among investors, in both the equities and real estate markets. Prices for single-family homes and condominiums in major cities like Munich, Hamburg, Frankfurt and Cologne are rising faster than rents, a sign that speculators are pushing their way into the market. Buyers are from Germany, Italy, Eastern Europe and Asia, and they are buying German real estate because they believe that by investing in "concrete gold," they can protect themselves against the dangers of inflation.

This buying frenzy creates potential trouble spots around the world. Real estate prices in major Chinese cities have increased by more than 20 percent in only a year, wealthy foreigners are snapping up luxury property in Istanbul, and in the United Kingdom the government is giving an additional boost to the economy by offering a special loan program for homebuyers.

In the last 12 months, real estate prices in the United States have gone up more than they have since 2006. Some cities, like San Francisco and Las Vegas, have even seen price increases of 24 to 27 percent. Ironically, the last crisis began in the overheated US housing market.

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1. when is the next crash
imihaeli 12/08/2013
The stock market in NY is all time high and it is inflated just like before the crash of 2008. Given the state of the economy in the US, which is in bad shape, there is no reason to celebrate. The economy never recovered despite what "the expert" told us. The financial industry lives in a different world and has no idea what reality is really. in the US there are two realities, Wall Street and Mains Street. The first does not reflects what reality is because the Federal government pumps in money to the banks.
2. What goes up must come down ?
uncleNT 12/08/2013
This does not apply where real estate is concerned because it is a finite commodity in a world of population explosion. However where debts exceed income on an ongoing basis a financial crash must be on the way.
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