If you’ve been watching financial markets for the past couple of years, you’ll know that the signs of a growing bubble are all around us. Stock and bond markets have been in bubbles for months, real estate prices are heating up again, and now private equity buyouts are at their highest level in a decade. But booming business isn’t necessarily a good sign.
Highest Level in a Decade
When you hear that something is “at the highest level since 2007” you can be pretty sure that it’s reaching bubble territory. The problem with unsustainable economic booms is that everyone assumes that the levels reached during the boom times are normal, and that is what they aspire to reach again.
It’s an attitude that crosses all business sectors, not just financial markets. Yes, as the economy grows it should eventually surpass the levels seen in 2007. But that growth needs to be sustainable and based on sound underlying economic fundamentals. Growth that is stimulated by artificially cheap credit can’t be maintained.
Everyone Feels Rich
The prosperity brought about by the boom times is illusory and only created by the central bank’s loose monetary policy. But very few people know and understand this. Everyone else feels rich, flush with cash, and they think the boom times will never end. “Dow 30,000 in five years!” you might hear some people say.
Companies such as private equity firms that are highly leveraged and rely on cheap debt to finance their acquisitions are particularly susceptible to this euphoria. They’re essentially playing with house money, being able to get loans for next to nothing, enabling them to make all sorts of acquisitions. But once interest rates start to rise, their investments suddenly don’t look so good. The companies that they acquired start to fail and soon the private equity firms themselves aren’t in great shape.
Protect Yourself Against the Bubble
An economy that has overheated because of cheap money and credit is an economy that is on the verge of a major crash. The business cycle is real and will continue as long as central banks continue to artificially lower interest rates. Students of economics know about the business cycle and its effects, which is why they aren’t susceptible to the allure of the perma-boom.