G20 finance ministers add to fears of a stock-market bubble

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G20 finance ministers add to fears of a stock-market bubble
To the list of worriers who feel financial markets are getting overheated, add 20 more.

Finance ministers from the Group of 20, which includes the United States, the U.K, the European Union and China, warned at their latest meeting that financial markets may be headed for a slump. “Downside risks persist, including in financial markets,” the group said in a statement from Cairns, Australia. “We are mindful of the potential for a build-up of excessive risk in financial markets, particularly in an environment of low interest rates and low asset price volatility.”

It’s unusual for government finance ministers to comment on the direction of financial markets, yet concern about inflated stock prices is now mainstream, as Aaron Task and I discuss in the video above. Since the market bottom in 2009, the S&P 500 has risen by about 200%, while overall U.S. economic output has only risen by about 20%. Stock prices relative to earnings are above historical averages. Many top investors have been predicting a market correction for months.

It hasn’t happened, of course. After rising 29% last year, the S&P 500 is up another 8% this year. Yet warning signs are everywhere. Inflation in Europe is so low there’s a risk of deflation, or falling prices, which would be a perverse development because falling prices discourage people from spending, since goods will be cheaper tomorrow. Super-low inflation usually gives a central bank more wiggle room to try monetary stimulus, but so far, the European Central Bank has been reluctant to enact the kind of quantitative easing the Federal Reserve did for nearly six years, beginning in late 2008. The G20 seems to be trying to nudge the ECB toward Fed-style easing — though, ironically, that might inflate stock values even more.

At the same time, big companies have been buying back their own shares at a record pace, which protects investors in the short term by pushing stock prices higher than they’d otherwise be, but has two major downsides. First, stock buybacks can mask underlying weaknesses in the stock market, since they make demand for stocks seem stronger than it is. That can breed complacency, which is one of the concerns now. Buybacks also make a company’s performance seem better than it is, since the stock usually rises on a buyback, even though earnings don’t.

The market has already brushed off many issues some analysts figured might trigger a correction. The war in Ukraine and sanctions on Russia haven’t dented the performance of stocks, nor has an outbreak of fighting in the Middle East or the spread of Ebola in Africa. Low interest rates could be adding to a stock bubble, since they’re forcing more and more investors to turn to the stock market for gains they can’t get in a savings account paying less than 1% interest.

The G20 does feel something is going right, pointing to strengthening growth in the United States and other parts of the world (but not Europe). A market correction, of course, could set back even those modest advances. No wonder they're worried.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.