- Investors have become complacent about risk, warns Larry Summers, and have succumbed to the kind of exuberance that preceded the 2008 crash or the dotcom collapse. A measure of underlying valuation in equity markets is at the top end of the range, and cryptocurrencies are booming.
Fear has surrendered to greed, with investors far too complacent about the growing imbalances in U.S. asset markets, Larry Summers warned.
In an interview with German business daily Handelsblatt, the former Treasury secretary said bullish sentiment reminded him of the giddy days that preceded the 2008 financial crisis and the dotcom bubble at the turn of the century.
However, this exuberance is misplaced, he says, amid lagging global growth, a Federal Reserve with precious little maneuvering room, and a United States whose finances haven’t been in this poor a shape in at least 160 years.
“The USA is facing its biggest fiscal sustainability problem since the Civil War certainly and quite possibly in its entire history,” Summers told the paper on the sidelines of the World Economic Forum in Davos. “The greatest danger threatening us is fearlessness itself.“
Fears businesses won’t have a level playing field under Trump
In a world where investors can expect an almost 5% risk-free return from Treasuries, companies could struggle to find sources of capital without paying through the nose. This could depress earnings growth that underpins valuation assumptions.
Moreover major investments that tend to pay dividends over the long term require the kind of planning certainty that lasts beyond election cycles. Summers didn’t specifically reference the issue, but the Trump administration’s decision to pull the U.S. out of the Paris climate accords a second time represents a third straight reversal in government policy in as many administrations.
Summers also appeared skeptical that Trump and his advisors would behave impartially by fostering a level playing field free from the need to declare political loyalty. Joe Biden warned in his final speech as president of the emergence of an oligarchy, a term normally reserved for Vladimir Putin’s Russia.
“There is that much more reason for concern when the business environment depends more on a small number of individuals rather than institutions that act in an unbiased manner,” Summers said in the Handelsblatt interview. “I understand the enthusiasm in the corporate community, but I’m afraid that enthusiasm could be like the one I saw in 2007 in Davos.”
That was shortly before the 2008–09 financial crisis began.
Shiller CAPE index near top end of its historical range
Current equity prices imply investors expect earnings growth to accelerate in the near future. One of the best measures of how bullish the asset markets are is the Shiller cyclically adjusted price-to-earnings (CAPE) ratio, which stands at a daunting 37 times average earnings for the benchmark S&P 500 index.
Today’s ratio is near the very top of the historical valuation range. That kind of level was last reached right before the Fed launched its rate hike cycle in early 2022 to combat multi-decade-high inflation and again right before the dotcom bust at the turn of the century—though there’s still some room to rise without entering unprecedented territory. The ratio hit a record-high 44 at the height of the dotcom bubble in 1999.
Part of the reason for today’s high value is that, even prior to Trump’s election, markets had been pricing in a productivity boom thanks to generative artificial intelligence. Now they expect on top a variety of stimulative measures, including a further cut to the corporate tax rate and tumbling energy prices as Trump exploits every domestic source of cheap, carbon-intensive fossil fuel he can find.
“I’m concerned about the complacency with which we view asset prices currently,” Summers said. He specifically cited the hype in meme stocks and crypto tokens, assets whose prices trade independent of financial fundamentals like cash flow and earnings.
Building a strategic reserve for Bitcoin is pointless at best
Investors may be in for a surprise, however, as Summers expects the Fed will have no choice but to tread carefully moving forward.
The former Harvard economist estimates the neutral level for the Fed funds rate—one neither overly restrictive nor overly accommodative—is already north of the 4% mark. This leaves little room to lower rates from their current 4.25% to 4.50% range.
Asked about Trump’s plans for a strategic Bitcoin reserve, Summers was at best neutral and at worst strictly opposed.
“I see the arguments for why we must build reserves of things needed in an emergency, so for example why we need a petroleum reserve, or stockpiles of other critical raw materials,” he replied. “I really don’t see what crisis for which we would need to prepare through a Bitcoin or crypto reserve. If the supporters of this idea only want governments to prop up the price of cryptocurrencies, then I am strictly against the idea.”
