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Risk On! Greed Is Back and That's Not Good

Stocks in this article: SCTY

NEW YORK (TheStreet) -- Warren Buffett said to "be fearful when others are greedy and greedy when others are fearful." Over the past five years, overall market sentiment has transitioned from extreme fear to "risk on" greed.

Yield-seeking behavior is leading investors to seek out riskier fixed-income assets, home prices are rising rapidly, equity market valuations are showing signs of froth and some risky "financial innovations" thought to be dead after the financial crisis are starting to return. Are you afraid yet?

According to Forbes, 2012 and 2013 saw the largest and second-largest issuance of junk bonds, going back to 2005, with $669B of new debt issued in those two years alone. As of Feb. 21, the yield spread between junk bonds and U.S. Treasuries was below four percentage points, with an average yield of just 5.37%. Meanwhile, underwriting fees for these bonds have dropped to the lowest on record. With interest rates so low and investor demand so high, firms are rushing to lever up.

The Wall Street Journal recently reported that nationwide home price gains in 2013 were the largest since 2005. Housing prices nationwide increased by an average of 6.4% between the fourth quarter 2012 and 4Q 2013 while rents only increased by 2.4%, according to Zillow.

In fact, in spite of historically low mortgage rates, RealtyTrac recently reported that it is once again cheaper to rent than to buy in many major markets (covering about 20% of the overall population of all counties analyzed), as buyers speculate on future price appreciation.

In equities, the initial public offering window is wide open as investor demand is very high. IPO pops of 50% or more are not uncommon as investors rush into the newest issues. Meanwhile, valuation multiples for established companies is well above historical norms. The current Shiller P/E 10 ratio is well above the historical mean and is approaching the levels seen in 2007.

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