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Robert Shiller rightly deserves his Nobel Prize as perhaps the world’s leading expert on asset bubbles. (I beat him by a year on the housing bubble in the United States.) But I think he gets the story badly wrong in making the case that there is currently a serious bubble in the U.S. stock market.
Shiller’s rationale is that the price-to-earnings ratio is well above its historic average. Furthermore, he points to the large stock plunges the last three times the price to earnings ratio approached current levels in 1929, 2000, and 2007.
There are two reasons I find the case less than compelling. First, it seems very plausible that people feel more comfortable investing in the stock market today than was the case thirty or forty years ago. This can be explained by the existence of index funds and the growth of defined contribution pensions. As a simple factual matter, a much larger percent of the population has stock holding today than was the case forty years ago, even if the distribution of holdings is still quite skewed.
The implication is that people if people view the market as less risky now than in the past, stock would command a lower risk premium than it had historically. This would justify a higher price-to-earnings ratio. This could mean that something like the ratio of 27 that Shiller calculates, compared to a long-term average of 17, could be reasonable. The ratio of 44 he calculated for 2000 clearly was not. (Note that the 2000 ratio is more than 60 percent higher than the current ratio.)
Btw, the tumble from 2007 peak was associated with a small detail: the collapse of the housing bubble and the ensuing financial crisis. I had warned of the market peak back then not because I thought stock prices were inherently too high, but that no one on Wall Street anticipated the devastation that would follow the collapse of the housing bubble.
The other reason why the current PEs in the stock market might be justified is that interest rates are well below their historic averages. With the nominal rate on 10-year Treasury bonds at just over 2.0 percent and the inflation rate around 1.6 percent, the real interest rate is roughly 0.5 percent. This compares to a long-period average in the range of 2.5-3.0 percent.
With the alternatives to holding stock offering returns that are far lower than they have in the past, it makes sense that people would be willing to accept a much lower return on their stock. The current PE should still allow a premium in the range of 4.0 percentage points relative to bonds, which is roughly the long period average. Of course if we had reason to expect that the real returns on bonds would rise sharply in the near future, then this argument would not carry much weight, but there does not appear to be any good story as to why real bond yields should be headed much higher in the near future.
In short, stocks do look high in the sense that people should expect lower returns in the future than the historic yield on stock, and they certainly should not expect to see anything like the run-up from 2009-2014. However, there is no reason to expect a sharp downturn barring a major downturn in the economy for reasons not currently in sight.
Robert Shiller rightly deserves his Nobel Prize as perhaps the world’s leading expert on asset bubbles. (I beat him by a year on the housing bubble in the United States.) But I think he gets the story badly wrong in making the case that there is currently a serious bubble in the U.S. stock market.
Shiller’s rationale is that the price-to-earnings ratio is well above its historic average. Furthermore, he points to the large stock plunges the last three times the price to earnings ratio approached current levels in 1929, 2000, and 2007.
There are two reasons I find the case less than compelling. First, it seems very plausible that people feel more comfortable investing in the stock market today than was the case thirty or forty years ago. This can be explained by the existence of index funds and the growth of defined contribution pensions. As a simple factual matter, a much larger percent of the population has stock holding today than was the case forty years ago, even if the distribution of holdings is still quite skewed.
The implication is that people if people view the market as less risky now than in the past, stock would command a lower risk premium than it had historically. This would justify a higher price-to-earnings ratio. This could mean that something like the ratio of 27 that Shiller calculates, compared to a long-term average of 17, could be reasonable. The ratio of 44 he calculated for 2000 clearly was not. (Note that the 2000 ratio is more than 60 percent higher than the current ratio.)
Btw, the tumble from 2007 peak was associated with a small detail: the collapse of the housing bubble and the ensuing financial crisis. I had warned of the market peak back then not because I thought stock prices were inherently too high, but that no one on Wall Street anticipated the devastation that would follow the collapse of the housing bubble.
The other reason why the current PEs in the stock market might be justified is that interest rates are well below their historic averages. With the nominal rate on 10-year Treasury bonds at just over 2.0 percent and the inflation rate around 1.6 percent, the real interest rate is roughly 0.5 percent. This compares to a long-period average in the range of 2.5-3.0 percent.
With the alternatives to holding stock offering returns that are far lower than they have in the past, it makes sense that people would be willing to accept a much lower return on their stock. The current PE should still allow a premium in the range of 4.0 percentage points relative to bonds, which is roughly the long period average. Of course if we had reason to expect that the real returns on bonds would rise sharply in the near future, then this argument would not carry much weight, but there does not appear to be any good story as to why real bond yields should be headed much higher in the near future.
In short, stocks do look high in the sense that people should expect lower returns in the future than the historic yield on stock, and they certainly should not expect to see anything like the run-up from 2009-2014. However, there is no reason to expect a sharp downturn barring a major downturn in the economy for reasons not currently in sight.
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Well, that may not be what they intended to point out, but it is in fact what they pointed out, according to the International Business Times. According to the paper:
“Critics point to the results in France and Italy, which have their own financial tax regimes. In Italy, average daily trading in Italian stocks dropped 29.7 percent in January and February 2014, compared to the average for the same period in 2013, Credit Suisse trading strategy analysts said last year.”
The tax rate on trades on exchanges was 0.1 percent on the transaction. If transactions costs averaged 0.3 percent before the tax, then this increased the cost per transaction by 33 percent to 0.4 percent. While the cost per trade will have risen by one third, the critics tell us that trading volume fell by 29.7 percent.
This means that Italian investors are actually spending 6.5 percent less on stock trades now than they did before the tax was put in place (0.703*1.33= 0.935). Since traders don’t on average make money on trading (some win and others lose), investors are actually saving money as a result of the tax. The full cost of the tax is therefore coming out of the pockets of the financial industry in the form of reduced trading volume. This would explain why they are critics of the tax.
Well, that may not be what they intended to point out, but it is in fact what they pointed out, according to the International Business Times. According to the paper:
“Critics point to the results in France and Italy, which have their own financial tax regimes. In Italy, average daily trading in Italian stocks dropped 29.7 percent in January and February 2014, compared to the average for the same period in 2013, Credit Suisse trading strategy analysts said last year.”
The tax rate on trades on exchanges was 0.1 percent on the transaction. If transactions costs averaged 0.3 percent before the tax, then this increased the cost per transaction by 33 percent to 0.4 percent. While the cost per trade will have risen by one third, the critics tell us that trading volume fell by 29.7 percent.
This means that Italian investors are actually spending 6.5 percent less on stock trades now than they did before the tax was put in place (0.703*1.33= 0.935). Since traders don’t on average make money on trading (some win and others lose), investors are actually saving money as a result of the tax. The full cost of the tax is therefore coming out of the pockets of the financial industry in the form of reduced trading volume. This would explain why they are critics of the tax.
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The NYT had an interesting map showing the extent to which countries trade with China as a way of illustrating its importance to the world economy. The main measure of the importance of trade with China is a circle showing the sum of imports and exports.
This is not really accurate, since the impact of a slowdown in China’s economy will be very different in its impact on imports and exports. If China’s economy’s slows sharply then the amount it imports from other countries will likely fall or at least grow considerably less rapidly than if its growth rate had been sustained.
On the other hand, there is no direct effect of slowing on China’s exports to its trading partners. There may be an indirect effect insofar as China’s slowing is associated with a lower value of its currency. In that case, its goods and services will become cheaper to its trading partners, which will likely lead to more rapid growth in Chinese imports by its trading partners. However this effect is likely to be considerably smaller than the impact on the exports of trading partners, which will fall due to both slower growth and changes in currency values.
It also would have been helpful if the numbers were expressed as shares of GDP. For example, Germany’s exports of $94 billion annually to China are far more important to its economy than the $153 billion exported by the United States, since the U.S. economy is more than four times as large as Germany’s.
The NYT had an interesting map showing the extent to which countries trade with China as a way of illustrating its importance to the world economy. The main measure of the importance of trade with China is a circle showing the sum of imports and exports.
This is not really accurate, since the impact of a slowdown in China’s economy will be very different in its impact on imports and exports. If China’s economy’s slows sharply then the amount it imports from other countries will likely fall or at least grow considerably less rapidly than if its growth rate had been sustained.
On the other hand, there is no direct effect of slowing on China’s exports to its trading partners. There may be an indirect effect insofar as China’s slowing is associated with a lower value of its currency. In that case, its goods and services will become cheaper to its trading partners, which will likely lead to more rapid growth in Chinese imports by its trading partners. However this effect is likely to be considerably smaller than the impact on the exports of trading partners, which will fall due to both slower growth and changes in currency values.
It also would have been helpful if the numbers were expressed as shares of GDP. For example, Germany’s exports of $94 billion annually to China are far more important to its economy than the $153 billion exported by the United States, since the U.S. economy is more than four times as large as Germany’s.
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The NYT told readers:
“The Federal Reserve has said that it expects to raise interest rates sometime soon, given evidence over the last year that economic growth is picking up.”
This undoubtedly had people wondering what the paper could have in mind. GDP growth has averaged less than 1.7 percent over the last three quarters. While employment growth has remained strong, the pace has slowed in recent months. Wages are barely keeping pace with inflation, with no sign of acceleration. Housing starts have picked up, but non-residential investment has been virtually flat.
In short, we are not looking at a story of the Fed raising rates in an economy that is picking up steam, rather the Fed seems to have lowered its expectations so that it is now prepared to raise rates and slow growth in an economy that is operating well below almost everyone’s estimates of potential GDP. What has changed is the Fed’s perceptions of an acceptable level of GDP and employment, not the economy.
The NYT told readers:
“The Federal Reserve has said that it expects to raise interest rates sometime soon, given evidence over the last year that economic growth is picking up.”
This undoubtedly had people wondering what the paper could have in mind. GDP growth has averaged less than 1.7 percent over the last three quarters. While employment growth has remained strong, the pace has slowed in recent months. Wages are barely keeping pace with inflation, with no sign of acceleration. Housing starts have picked up, but non-residential investment has been virtually flat.
In short, we are not looking at a story of the Fed raising rates in an economy that is picking up steam, rather the Fed seems to have lowered its expectations so that it is now prepared to raise rates and slow growth in an economy that is operating well below almost everyone’s estimates of potential GDP. What has changed is the Fed’s perceptions of an acceptable level of GDP and employment, not the economy.
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Andrew Ross Sorkin seems prepared to pronounce Ken Rogoff to be prescient once again with his prediction that China would run into a debt crisis. Rogoff’s past claims to prescience might be viewed as somewhat questionable. He, along with co-author Carmen Reinhardt, famously argued that countries face a severe slowdown in growth when their debt to GDP ratios exceed 90 percent. It turned out that this claim was driven by an error in an Excel spreadsheet, nonetheless it was used to justify austerity in the euro zone, the United States and elsewhere. This austerity did help to worsen the downturns caused by the collapse of asset bubbles, in effect contributing to the crisis that Sorkin credits Rogoff with predicting.
Anyhow, the jury is still out as to whether China will face a serious slump due to its market downturn, as Rogoff himself is quoted as saying in Sorkin’s piece. The prediction on which Rogoff and just about everyone else in the world has been proven correct is that China’s stock market bubble would burst. (It had risen by 150 percent between June of 2014 and June of 2015.) Rogoff does not seem prepared to say even now that this will lead to a more general collapse of China’s economy.
Andrew Ross Sorkin seems prepared to pronounce Ken Rogoff to be prescient once again with his prediction that China would run into a debt crisis. Rogoff’s past claims to prescience might be viewed as somewhat questionable. He, along with co-author Carmen Reinhardt, famously argued that countries face a severe slowdown in growth when their debt to GDP ratios exceed 90 percent. It turned out that this claim was driven by an error in an Excel spreadsheet, nonetheless it was used to justify austerity in the euro zone, the United States and elsewhere. This austerity did help to worsen the downturns caused by the collapse of asset bubbles, in effect contributing to the crisis that Sorkin credits Rogoff with predicting.
Anyhow, the jury is still out as to whether China will face a serious slump due to its market downturn, as Rogoff himself is quoted as saying in Sorkin’s piece. The prediction on which Rogoff and just about everyone else in the world has been proven correct is that China’s stock market bubble would burst. (It had risen by 150 percent between June of 2014 and June of 2015.) Rogoff does not seem prepared to say even now that this will lead to a more general collapse of China’s economy.
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If folks can take a break from worrying about how robots are going to take all the jobs, they may want to look at a NYT piece on Japan’s excess supply of housing. The basic story is that because of Japan’s declining population there are now hundreds of thousands of homes across the country that are sitting empty because no one wants them.
While this is an interesting and important story, the piece also includes the standard nonsense about the demographics of an aging population devastating Japan’s economy. It tells readers:
“The demographic pressure has weighed on the Japanese economy, as a smaller work force struggles to support a growing proportion of the old.”
Let’s see, if the smaller workforce is struggling to support a growing population of elderly they must be working weekends and overtime to make up for the shortage of workers. It seems the OECD hasn’t gotten word of these struggles. According to its data, the average work year has fallen from 2,121 hours in 1980 to 1,734 hours in 2013. If Japanese workers put in as many hours today as their counterparts did three decades ago, it would give them the equivalent of 22.3 percent more workers. It’s hard to see the evidence of the struggle in these numbers.
The piece also comments that Japan is:
“still building more than 800,000 new homes and condominiums a year, despite the glut of vacancies.”
Maybe if the country is having such a hard time meeting the needs of its retirees, it should spent fewer resources building homes that may not be needed.
Seriously, the effects of productivity growth swamp the demographic changes that the elites keep yapping about. If Japan could lift its rate of annual productivity growth by 0.5 percentage points over the next thirty years, it would swamp the impact of its aging population. If we believe anything remotely like the robot taking our jobs story, then aging is nothing to worry about. In fact, it is a good thing since it means there are fewer people for whom we have to find work.
If folks can take a break from worrying about how robots are going to take all the jobs, they may want to look at a NYT piece on Japan’s excess supply of housing. The basic story is that because of Japan’s declining population there are now hundreds of thousands of homes across the country that are sitting empty because no one wants them.
While this is an interesting and important story, the piece also includes the standard nonsense about the demographics of an aging population devastating Japan’s economy. It tells readers:
“The demographic pressure has weighed on the Japanese economy, as a smaller work force struggles to support a growing proportion of the old.”
Let’s see, if the smaller workforce is struggling to support a growing population of elderly they must be working weekends and overtime to make up for the shortage of workers. It seems the OECD hasn’t gotten word of these struggles. According to its data, the average work year has fallen from 2,121 hours in 1980 to 1,734 hours in 2013. If Japanese workers put in as many hours today as their counterparts did three decades ago, it would give them the equivalent of 22.3 percent more workers. It’s hard to see the evidence of the struggle in these numbers.
The piece also comments that Japan is:
“still building more than 800,000 new homes and condominiums a year, despite the glut of vacancies.”
Maybe if the country is having such a hard time meeting the needs of its retirees, it should spent fewer resources building homes that may not be needed.
Seriously, the effects of productivity growth swamp the demographic changes that the elites keep yapping about. If Japan could lift its rate of annual productivity growth by 0.5 percentage points over the next thirty years, it would swamp the impact of its aging population. If we believe anything remotely like the robot taking our jobs story, then aging is nothing to worry about. In fact, it is a good thing since it means there are fewer people for whom we have to find work.
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In his two months as a candidate for the Republican presidential nomination, Donald Trump has said many things that are racist, sexist, or otherwise offensive, but that doesn’t mean that everything he says is off the mark. The Wall Street Journal took Trump to task yesterday for dismissing the relatively low official unemployment rate and instead focusing on the large number of people who are not working.
While the WSJ is right that the vast majority of people who are not working are people who chose not to work. These are older people who are retired, young people who are still in school, or people who are taking time out of the labor force to care for children or other family members.
Nonetheless, even if we control for changes in demographics there has been a sharp decline in the employment rate of prime-age workers (ages 25-54) from the pre-recession level. The employment rate of prime age workers is still down by almost three percentage points from its pre-recession level and almost four percentage points from its peak in 2000.
While many analysts try to explain this falloff with vigorous hand waving, it is almost certainly due primarily to the weakness of the labor market. It is implausible that millions of prime-age workers suddenly decided that they don’t feel like working. Trump is right to call attention to the drop off in employment, even if he is wrong to be worried that our grandparents or teenage children aren’t working.
In his two months as a candidate for the Republican presidential nomination, Donald Trump has said many things that are racist, sexist, or otherwise offensive, but that doesn’t mean that everything he says is off the mark. The Wall Street Journal took Trump to task yesterday for dismissing the relatively low official unemployment rate and instead focusing on the large number of people who are not working.
While the WSJ is right that the vast majority of people who are not working are people who chose not to work. These are older people who are retired, young people who are still in school, or people who are taking time out of the labor force to care for children or other family members.
Nonetheless, even if we control for changes in demographics there has been a sharp decline in the employment rate of prime-age workers (ages 25-54) from the pre-recession level. The employment rate of prime age workers is still down by almost three percentage points from its pre-recession level and almost four percentage points from its peak in 2000.
While many analysts try to explain this falloff with vigorous hand waving, it is almost certainly due primarily to the weakness of the labor market. It is implausible that millions of prime-age workers suddenly decided that they don’t feel like working. Trump is right to call attention to the drop off in employment, even if he is wrong to be worried that our grandparents or teenage children aren’t working.
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Joe Nocera rightly takes Jeff Bezos to task for making Amazon an undesirable place to work. (Sorry, I have more sympathy for the warehouse staff in overheated warehouses than the overachievers who are treated poorly at headquarters.) However he gets one part of the story wrong.
He tells readers:
“Practically from the moment Amazon went public in 1997, Wall Street has pleaded with Bezos to generate more profits. He has ignored those pleas, and has plowed potential profits back into the company. Bezos believes that if Amazon puts the needs of its customers first — and no company is more maniacally focused on customers — the stock will take care of itself. That’s exactly what has happened. That is the good side of Bezos’s indifference to the opinion of others.”
While it is clear that the stock market has rewarded Amazon, just as it rewarded AOL.com in the 1990s bubble, it is not clear that Amazon had “potential profits” to plow back. Profits are independent of investment decisions, at least if a company is not engaged in accounting fraud. Amazon may have kept prices low to expand market share, thereby depriving itself of profits, but then it doesn’t have money to plow back either. It is very hard to make sense of the assertion that Amazon somehow doesn’t have profits because it is re-investing, although if it gets not very bright market actors to believe it, Amazon’s share price can continue to rise.
It is also important to note the big handout that Amazon has relied upon from taxpayers. Amazon has not had to collect sales tax in most states for most of its existence, giving the company an enormous subsidy in its competition with brick and mortar competitors. The cumulative size of this subsidy almost certainly exceeds its cumulative profits in the years that it has been in existence. Any discussion of Bezos success should mention this huge subsidy from the government.
Joe Nocera rightly takes Jeff Bezos to task for making Amazon an undesirable place to work. (Sorry, I have more sympathy for the warehouse staff in overheated warehouses than the overachievers who are treated poorly at headquarters.) However he gets one part of the story wrong.
He tells readers:
“Practically from the moment Amazon went public in 1997, Wall Street has pleaded with Bezos to generate more profits. He has ignored those pleas, and has plowed potential profits back into the company. Bezos believes that if Amazon puts the needs of its customers first — and no company is more maniacally focused on customers — the stock will take care of itself. That’s exactly what has happened. That is the good side of Bezos’s indifference to the opinion of others.”
While it is clear that the stock market has rewarded Amazon, just as it rewarded AOL.com in the 1990s bubble, it is not clear that Amazon had “potential profits” to plow back. Profits are independent of investment decisions, at least if a company is not engaged in accounting fraud. Amazon may have kept prices low to expand market share, thereby depriving itself of profits, but then it doesn’t have money to plow back either. It is very hard to make sense of the assertion that Amazon somehow doesn’t have profits because it is re-investing, although if it gets not very bright market actors to believe it, Amazon’s share price can continue to rise.
It is also important to note the big handout that Amazon has relied upon from taxpayers. Amazon has not had to collect sales tax in most states for most of its existence, giving the company an enormous subsidy in its competition with brick and mortar competitors. The cumulative size of this subsidy almost certainly exceeds its cumulative profits in the years that it has been in existence. Any discussion of Bezos success should mention this huge subsidy from the government.
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