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Harvard Endowment Chief Warns Of Market Froth, Compares Rate Hike To Bubble-Bursting Catalyst

It's not just Fed chair Janet Yellen warning about valuations which are "quite high" - add Harvard University's endowment President and CEO Stephen Blyth to the list of voice warning about overstretched markets.

In the just released annual endowment report Blyth warns that that "market is potentially frothy", not only in the public equity space, but in PE and VCs as well. In other words, everywhere. He also warns that nobody knows what happens when central bank training wheels are finally removed from the market.

Finally, and most ominously for all those screaming they demand a Fed rate hike, Blyth compares a Fed rate hike to the catalyst the unleashed the great financial crisis: falling house prices. Just in case there is still any confusion as to the real reason why nine years later, the Fed is so terrified to hike rates.

From the letter:

The debate about highly-valued assets continues to get louder: private equity valuations are now, on average, at higher levels than in 2007. There are over eighty “unicorns” (venture-capital portfolio companies with valuations over $1 billion), as many as in the last three years combined. Venture capital continues to receive ample funding, and private company valuations are also bolstered by public mutual funds entering late stage funding rounds in significant size. This environment is likely to result in lower future returns than in the recent past.

 

It is hard to know the impact of the eventual rise of interest rates in the US on asset classes domestically and globally. Monetary accommodation in the US has been in place for almost eight years, since the first Federal Reserve intervention on 11 December 2007, the Term Auction Facility (TAF). An extensive number of policy interventions, with a long lexicon of acronyms, followed. As hard as it was to predict the impact of these policy actions, it will be equally hard to predict the effect of their removal. We are analyzing potential effects of higher rates throughout the portfolio, in particular examining the possibility of second order effects if many asset classes (e.g., bonds, high-yielding stocks, high-yield debt, emerging markets and real estate) were to decline simultaneously. An interesting question emerges: could rising interest rates in 2016 have an analogous impact to falling house prices in 2007, where a range of largely unanticipated second-order effects was triggered?

 

We are proceeding with caution in several areas of the portfolio: many of our absolute return managers are accumulating increasing amounts of cash; we are being careful about not over-committing into illiquid investments in potentially frothy markets, while still ensuring we will be involved if market dislocations arise; and we are being particularly discriminating about underwriting and return assumptions given current valuations. In addition, we have renewed focus on identifying public equity managers with demonstrable investment expertise on both the long and short sides of the market. And we are concentrating on investment opportunities with idiosyncratic features that still offer value creation, such as the life science laboratory space, and the retail sector where transformation continues at rapid pace.

We doubt he will be invited on CNBC.