February 6, 2013 / 9:36 PM / in 5 years

COLUMN-They are playing the Chuck Prince Waltz: James Saft

(James Saft is a Reuters columnist. The opinions expressed are his own.)

By James Saft

Feb 6 (Reuters) - The music is playing again and the pressure for investors to get out on the dance floor is, like in 2007, intense.

By most measures financial conditions are as easy, as relaxed, as at any time since the summer of 2007, meaning that markets and investors simply aren’t demanding that much compensation for taking on risk.

That does not in and of itself mean that a rout is coming, nor does it mean that the rally can’t continue, but it does imply we should be very cautious about the returns we’ll get from here.

While the Federal Reserve, in creating very easy monetary conditions, gets prime responsibility for the rally, credit a big assist to human nature and incentives within financial services, neither of which has changed much since 2007.

Put simply, if you are not doing deals and putting money to work now, you are taking your job in your hands.

Charles O. Prince, then CEO of Citgroup, illustrated this mindset most ably in July of 2007.

“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,” Prince, who later stepped down amid massive losses at Citi, told the Financial Times.

That was true then, and it is now, both in terms of the complications to come and the imperative to dance now. Had Prince been more conservative, much less been willing to stand as one man against the tide of liquidity, he wouldn’t have been the head of Citigroup. And it’s nice to be head of Citigroup, or so they tell me.

And while there are investors out there, notably Dan Fuss of Loomis, Sayles & Company, who are willing to speak plainly about how loose things are, they are the exception and they are feeling the heat. The capital markets are not designed to go home early when there is an open bar still running.

By their nature, things in financial markets take on a self-propelling momentum and, inevitably, go too far. Those are two different things, however, and frankly, it is not clear that we have yet gone too far. We may well have gone beyond reasonable valuations for some assets, but that has been true well below the peak many times before.

According to the Financial Stress Index, an amalgam of 18 indicators monitored by the St Louis Federal Reserve, markets are now as blissed out as they have been at any time since August of 2007, just after Prince wrote his epitaph. And while current readings are less relaxed and easy than they were at the height of the boom in 2005 and 2006, they are about on par with the range the market enjoyed during much of the late 1990s, another boom period for markets.


Unlike 2007 and 1999 there isn’t this time an obvious bubble in a particular asset. We have nothing analogous to dotcom stocks or housing plays. While portions of the bond market are very clearly out of whack - notably high yield debt, financial markets generally seem pleasantly anesthetized rather than comatose.

There are plenty of candidates for the locus of a bubble - the great energy renaissance in the U.S. to name two - but nothing has emerged as a general mania.

Still, the bullishness across markets is striking, and should be sobering. Allocations to stock markets among individual investors have risen markedly, according to a survey by the American Association of Individual Investors, and cash levels in typical portfolios are about a quarter below their historical average.

The same thing is true among professional investment managers, according to a regular survey by the National Association of Active Investment Managers. NAAIM data show managers as bullish as at any time since March of 2007, and other than that month, more bullish than at any time since the survey began in 2006.

The main underpinning of all of this is the policy of central banks. The Fed and many others are purchasing assets, and the ECB has written us all disaster insurance against the break-up of the euro. It remains to be seen how effective this will ultimately be in the real economy, though there are bright spots like housing, but it is working very well in financial markets.

None of this means we won’t get a correction, but for this bull market to turn bear we probably need an outside shock, always a possibility but a tough thing to base strategy on. It also doesn’t mean we will get good returns out of a typical mixed portfolio of stocks and bonds, especially on a three of five year view.

Call it a cynical rally but for now, at least, so long as the Fed liquidity flows, the music and dancing don’t look ready to stop.

At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns atblogs.reuters.com/james-saft Jim Saft

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