The Share Centre - Why asset prices may be overvalued two times over

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Michael Baxter

Why asset prices may be overvalued two times over

Written by: Michael Baxter on May 22nd 2015

Category: Thought for the day

Inflation is something that happens from time to time. Trace things back to the Middle Ages as this chart does, and you will see what I mean.




The chart forms part of a new book called Inflation Matters, and its author Pete Comley gave a great talk the other day at the ERC, which I found fascinating.

There have been four episodes of inflation over the last 750 years or so, the current phase is around 115 years old, and probably has no more than a decade or so left to run 

So what causes it? What causes inflation, that is?

It appears that in the long-term, the key factor is demographics. Mr Comley has managed to show a neat correlation between inflation and population growth over the last millennium. Nasty demographics shocks, such as the Black Death, seemed to correspond with a period of zero inflation.

As I said in yesterday’s Thought for the Day,  we have a big demographic shock coming our way. This implies that the era of inflation is close to ending. 

However, Mr Comley reckons that another factor comes into play in the medium-term and that is the money supply. He has compared growth in the broad money supply with inflation going back to 1900. Between 1900 and 1980, the match was almost perfect. Then we saw a sharp divergence around 1980. The money supply kept growing, but inflation slowed.

Mr Comley reckons that, based on growth in the money supply, average prices should double. That is to say, we are due to see 100 per cent inflation, for a short period, while prices rise to reflect the growth in the money supply, seen in the last few decades.

So far, however, instead of rising prices, since 1980 we have seen rising asset prices. In short, the growth in the money supply fed an asset price boom.

What will happen next? He suggests that prices will double, or the money supply will contract, presumably this will reverse the growth in asset pries we have seen in the last few decades, and they will halve in value, or governments will start defaulting worldwide.

Of course, this is what nearly happened in 2008. The money supply did seem to be on the verge of crashing. Instead, governments bailed out the banks, and central banks engaged in QE. I guess this all lends support to the idea that QE has blown one mighty bubble.

Mr Comley suggests that the end of inflation is not necessarily a bad thing. It will mean greater certainty, and will help to put an end to zombie companies, and mean more investment with fewer share buybacks.

He says that in the short-term shares, and property will be the big winners, with precious metals, savings and local currency cash being the big losers.

In the medium-term, he says precious metals, savings, local currency and digital currencies will be winners. Losers will be shares, government bonds, corporate bonds, commodities (other than previous metals), and property. In the long-term, shares, corporate bonds and savings will be winners, and precious metals will be losers.

You could characterise it all thus. Sell gold, then buy, then sell. Buy shares, then sell, then buy. Buy property, then sell, then hold.

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees.

Tags: Inflation matters, Pete Comley, history of inflation, long run investing, prospects for inflation

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