The IMF Calls Asset Prices ‘Stretched’

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The International Monetary Fund has joined the bears, warning that assets are overvalued and that markets are unusually calm considering how unimpressive the global recovery has been and the risks that we’re facing over the next year.

“Valuations in virtually all major asset classes are stretched relative to past norms,” says the IMF report prepared ahead of this weekend’s G20 meeting in Australia. “Long-term bond yields have declined further especially in the euro area but also in the United States and in most emerging economies. Equity valuations have continued to edge higher, as investor sentiment has remained positive despite mixed evidence on the strength of the recovery and geopolitical tensions.”

Asset prices: Implied volatility has remained low despite new risks, says IMF

The IMF report doesn’t dwell on any specific valuation metrics, taking it as fairly self-evident that asset prices are high, and instead focuses on implied volatility. Implied volatility fell steadily for more than a year before former Fed chairman Ben Bernanke mentioned that quantitative easing would eventually come to an end, jumping immediately to late-2011 levels. Volatility has been falling since then (with a spike last August when President Obama was considering going to war in Syria over chemical weapons) and is now back to early-2013 levels.

So last year the mention of tapering and the possibility of war in Syria sent volatility climbing, while this year the actual end of QE, war (depending on which administration official you ask) against ISIS in Iraq and Syria, and tensions between Ukraine and Russia are taken in stride.

“This raises concerns of a buildup of excessive leverage and under-pricing of credit risk which could be abruptly corrected in the run-up to U.S. rate hikes or because of higher global risk aversion,” says the report, which also cites the risk of deflation in Japan and the eurozone and prolonged secular stagnation among developed economies in general as problems that the markets could be more concerned about.

Asset Prices: IMF recommendations for the G20 summit

Aside from worrying about asset prices, the IMF’s main recommendations ahead of the G20 summit are for continued DM monetary accommodation as long as there are “large output gaps and very low inflation,” and for deficit countries (especially in the EU) to enact structural reform to improve competitiveness. The IMF also recommends that emerging markets start preparing now for the higher rates and tighter financing that is likely coming soon, and that surplus economies work to bolster domestic demand in case global demand slips again in the future.

H/T Barbara Kollmeyer Of MarketWatch

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