Washington Post columnist Steve Pearlstein argues it is, taking issue with fellow columnist Barry Ritholtz who says it isn’t. I’m going to come down in the middle here.
The market is somewhat above its historic levels relative to trend earnings. Pearlstein cites Shiller who puts the price to earnings ratio at 25 to 1, compared to a historic average of 16. (Pearlstein seems to place a lot of faith in Shiller who he tells us got a Nobel for his knack for spotting bubbles. Shiller may have gotten the Nobel, but I got the bubble story right. In 2003 he argued that there was no bubble in the housing market by making a comparison of real house prices and real incomes. I had recognized the bubble a year earlier by noting that inflation adjusted house prices had been rising since the late 1990s after remaining largely flat for the prior half century. Shiller later did research agreeing with my assessment that quality-adjusted house prices should track inflation, not income.) Anyhow, I would agree that stock prices are somewhat above trend, but not by quite as large a margin as Shiller.
To get some perspective, at the peak of the stock bubble in early 2000, the S&P peaked at just under 1530. The economy is almost than 70 percent larger today (in nominal dollars), which would mean that the S&P would be over 2600 today if it were as high relative to the economy. If we throw in that the economy is still operating at 5 percent below its potential then the S&P would have to be over 2700 now to be as high relative to the economy as it was at the peak of the stock bubble. With a Friday close of 1863, we can see the market is at a level that is a bit more than two thirds of its 2000 bubble peak, relative to the size of the economy.
It also is much lower relative to the economy than it was in 2007 when almost no one was talking about a stock bubble. The S&P peaked at just over 1560 in the fall of 2007. Taking into account the economy’s 18 percent nominal growth over this period, and the fact that we are still 5 percent below potential GDP, the S&P would have to be over 1900 today to be as high relative to potential GDP as it was in 2007. Given recent patterns, it certainly doesn’t make sense to talk about a bubble for the market as a whole.
However, there are some points worth noting. The social media craze has allowed many companies with no profits and few prospects for making profits to market valuations in the hundreds of millions or even billions of dollars. That sure looks like the Internet bubble. Some of these companies may end up being profitable and worth something like their current share price. The vast majority probably will not.
The other point is that the higher than trend price to earnings ratio means that we should expect to see lower than trend real returns going forward. This is an important qualification to Ritholtz’s analysis. While there is no reason that people should fear that stocks in general will take a tumble, as they did in 2000-2002, they also would be nuts to expect the same real returns going forward as they saw in the past.
With a price to earnings ratio that is roughly one-third above the long-term trend, they should expect real returns that are roughly one-third lower than the historic average. This means that instead of expecting real returns on stock of 7.0 percent, they should expect something closer to 5.0 percent. That might still make stocks a good investment, especially in the low interest rate environment we see today, but probably not as good as many people are banking on.
In short, there is not much basis for Pearlstein’s bubble story, but we should also expect that because of higher than trend PE ratios stocks will not provide the same returns in the future as they did in the past. Anyone who thinks we can better have their calculator checked.
Washington Post columnist Steve Pearlstein argues it is, taking issue with fellow columnist Barry Ritholtz who says it isn’t. I’m going to come down in the middle here.
The market is somewhat above its historic levels relative to trend earnings. Pearlstein cites Shiller who puts the price to earnings ratio at 25 to 1, compared to a historic average of 16. (Pearlstein seems to place a lot of faith in Shiller who he tells us got a Nobel for his knack for spotting bubbles. Shiller may have gotten the Nobel, but I got the bubble story right. In 2003 he argued that there was no bubble in the housing market by making a comparison of real house prices and real incomes. I had recognized the bubble a year earlier by noting that inflation adjusted house prices had been rising since the late 1990s after remaining largely flat for the prior half century. Shiller later did research agreeing with my assessment that quality-adjusted house prices should track inflation, not income.) Anyhow, I would agree that stock prices are somewhat above trend, but not by quite as large a margin as Shiller.
To get some perspective, at the peak of the stock bubble in early 2000, the S&P peaked at just under 1530. The economy is almost than 70 percent larger today (in nominal dollars), which would mean that the S&P would be over 2600 today if it were as high relative to the economy. If we throw in that the economy is still operating at 5 percent below its potential then the S&P would have to be over 2700 now to be as high relative to the economy as it was at the peak of the stock bubble. With a Friday close of 1863, we can see the market is at a level that is a bit more than two thirds of its 2000 bubble peak, relative to the size of the economy.
It also is much lower relative to the economy than it was in 2007 when almost no one was talking about a stock bubble. The S&P peaked at just over 1560 in the fall of 2007. Taking into account the economy’s 18 percent nominal growth over this period, and the fact that we are still 5 percent below potential GDP, the S&P would have to be over 1900 today to be as high relative to potential GDP as it was in 2007. Given recent patterns, it certainly doesn’t make sense to talk about a bubble for the market as a whole.
However, there are some points worth noting. The social media craze has allowed many companies with no profits and few prospects for making profits to market valuations in the hundreds of millions or even billions of dollars. That sure looks like the Internet bubble. Some of these companies may end up being profitable and worth something like their current share price. The vast majority probably will not.
The other point is that the higher than trend price to earnings ratio means that we should expect to see lower than trend real returns going forward. This is an important qualification to Ritholtz’s analysis. While there is no reason that people should fear that stocks in general will take a tumble, as they did in 2000-2002, they also would be nuts to expect the same real returns going forward as they saw in the past.
With a price to earnings ratio that is roughly one-third above the long-term trend, they should expect real returns that are roughly one-third lower than the historic average. This means that instead of expecting real returns on stock of 7.0 percent, they should expect something closer to 5.0 percent. That might still make stocks a good investment, especially in the low interest rate environment we see today, but probably not as good as many people are banking on.
In short, there is not much basis for Pearlstein’s bubble story, but we should also expect that because of higher than trend PE ratios stocks will not provide the same returns in the future as they did in the past. Anyone who thinks we can better have their calculator checked.
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Joe Nocera documents what many of us already knew, the multi-million dollar pay packages of corporate CEOs are a matter between friends, not a market relationship. The specific context is the pay of the CEO and other top executives at Coca Cola.
The company has recently been in the news since an activist investor calculated it had set aside $24 billion for management bonuses over a two-year period. An amount that came to $2 million for each person in the pool. Nocera focused on the reaction of Warren Buffett to this news. As a result of his control over Berkshire Hathaway, Buffet is effectively one of the company’s largest shareholders. Buffett has repeatedly complained publicly about outlandish CEO pay packages.
For this reason it seemed reasonable to expect that Buffett would use his shares to vote no when the pay package for Coke’s top executive was put to a vote. However Nocera reports that he chose to abstain. Buffett’s rationale, as relayed through third parties, is that it would have been too confrontational to vote down the package. Essentially Buffett said that he thought the pay was too high, but that he didn’t want to make waves. He also acknowledged supporting other pay packages as a director that he felt were too high in order not to make waves.
This beautifully illustrates the dynamics of CEO pay. This is not a market relationship, it is a deal between friends.
When it comes to the pay of ordinary workers, whether clerks in a Walmart or factory workers in the auto industry, the question is always whether the company can get away with paying less. If lower pay means lobbying against minimum wage hikes or shipping work overseas, it will be done in a second, no apologies made. The story is that the goal is to maximize profits.
Yet, the same corporate board members who tell us about representing shareholders’ when it comes to the pay of ordinary workers, somehow get all touchy feely when it comes to the pay of CEOs and other top management. This was the reason that CEPR started Director Watch and worked with Huffington Post on its Pay Pals site.
The corporate directors are the ones who most immediately need to be harassed. These are mostly prominent public figures (our list of directors profiled to date includes Erskine Bowles, Richard M. Daley, Elaine Chou, and Judith Rodin). They are paid six figure salaries to go to a small number of meetings a year. Their main responsibility is to ensure that management is acting on behalf of the shareholders.
When directors approve exorbitant pay packages even for mediocre CEOs, they cannot claim they are doing their jobs. They are essentially getting paid off to look the other way.
Note: Typos corrected.
Joe Nocera documents what many of us already knew, the multi-million dollar pay packages of corporate CEOs are a matter between friends, not a market relationship. The specific context is the pay of the CEO and other top executives at Coca Cola.
The company has recently been in the news since an activist investor calculated it had set aside $24 billion for management bonuses over a two-year period. An amount that came to $2 million for each person in the pool. Nocera focused on the reaction of Warren Buffett to this news. As a result of his control over Berkshire Hathaway, Buffet is effectively one of the company’s largest shareholders. Buffett has repeatedly complained publicly about outlandish CEO pay packages.
For this reason it seemed reasonable to expect that Buffett would use his shares to vote no when the pay package for Coke’s top executive was put to a vote. However Nocera reports that he chose to abstain. Buffett’s rationale, as relayed through third parties, is that it would have been too confrontational to vote down the package. Essentially Buffett said that he thought the pay was too high, but that he didn’t want to make waves. He also acknowledged supporting other pay packages as a director that he felt were too high in order not to make waves.
This beautifully illustrates the dynamics of CEO pay. This is not a market relationship, it is a deal between friends.
When it comes to the pay of ordinary workers, whether clerks in a Walmart or factory workers in the auto industry, the question is always whether the company can get away with paying less. If lower pay means lobbying against minimum wage hikes or shipping work overseas, it will be done in a second, no apologies made. The story is that the goal is to maximize profits.
Yet, the same corporate board members who tell us about representing shareholders’ when it comes to the pay of ordinary workers, somehow get all touchy feely when it comes to the pay of CEOs and other top management. This was the reason that CEPR started Director Watch and worked with Huffington Post on its Pay Pals site.
The corporate directors are the ones who most immediately need to be harassed. These are mostly prominent public figures (our list of directors profiled to date includes Erskine Bowles, Richard M. Daley, Elaine Chou, and Judith Rodin). They are paid six figure salaries to go to a small number of meetings a year. Their main responsibility is to ensure that management is acting on behalf of the shareholders.
When directors approve exorbitant pay packages even for mediocre CEOs, they cannot claim they are doing their jobs. They are essentially getting paid off to look the other way.
Note: Typos corrected.
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The New York Times ran a piece reporting that more Democrats running for election this year are openly campaigning on the Affordable Care Act. The piece noted that eight million people had signed up for the exchanges by the end of the open enrollment period. While this is a large base of people who may perceive themselves as benefiting from the law, it is worth noting that this number is likely to increase substantially in the months leading up to the election.
Under the law, people who face a “life event” become eligible for insurance in the exchange. Life events include job loss, divorce, death in the family, and the birth of a new child. Every month roughly four million people leave their jobs. If just one in five of these people go from a job with insurance to either being unemployed or a job without insurance, it would mean another 800,000 people are becoming eligible for the exchanges every month for this reason alone.
This means that the number of people who will have had the opportunity to buy insurance through the exchanges by election will be far higher than the number currently enrolled. Since many of these people will have found themselves unexpectedly without insurance, they are likely to especially value the opportunity to buy insurance on the exchanges.
The New York Times ran a piece reporting that more Democrats running for election this year are openly campaigning on the Affordable Care Act. The piece noted that eight million people had signed up for the exchanges by the end of the open enrollment period. While this is a large base of people who may perceive themselves as benefiting from the law, it is worth noting that this number is likely to increase substantially in the months leading up to the election.
Under the law, people who face a “life event” become eligible for insurance in the exchange. Life events include job loss, divorce, death in the family, and the birth of a new child. Every month roughly four million people leave their jobs. If just one in five of these people go from a job with insurance to either being unemployed or a job without insurance, it would mean another 800,000 people are becoming eligible for the exchanges every month for this reason alone.
This means that the number of people who will have had the opportunity to buy insurance through the exchanges by election will be far higher than the number currently enrolled. Since many of these people will have found themselves unexpectedly without insurance, they are likely to especially value the opportunity to buy insurance on the exchanges.
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In her Washington Post column Catherine Rampell correctly pointed out that the median return in higher wages for those with college degrees more than covers the tuition and opportunity cost associated with attending college. She notes however that college enrollment has edged downward in recent years.
While she sees this decline largely as the result of young people failing to recognize the benefits of college, it can be more readily explained by a growing divergence in the income of college grads. Work by my colleague John Schmitt and Heather Boushey shows that a substantial proportion of college grads, especially male college grads, earn less than the average high school grad. They found that the lowest earning quintile of recent college grads (ages 25-34) earned less than the average high school grad. The implication is that many young people may be reasonably assessing their risks of not being a winner among college grads and therefore opting not to get additional education. To get more young people to attend college it is important that most can predictably benefit from the additional education, not just that the average pay of college grads rises. (of course the story would be worse for those who start college and do not finish.)
Note: typos were corrected and the comparison was clarified.
In her Washington Post column Catherine Rampell correctly pointed out that the median return in higher wages for those with college degrees more than covers the tuition and opportunity cost associated with attending college. She notes however that college enrollment has edged downward in recent years.
While she sees this decline largely as the result of young people failing to recognize the benefits of college, it can be more readily explained by a growing divergence in the income of college grads. Work by my colleague John Schmitt and Heather Boushey shows that a substantial proportion of college grads, especially male college grads, earn less than the average high school grad. They found that the lowest earning quintile of recent college grads (ages 25-34) earned less than the average high school grad. The implication is that many young people may be reasonably assessing their risks of not being a winner among college grads and therefore opting not to get additional education. To get more young people to attend college it is important that most can predictably benefit from the additional education, not just that the average pay of college grads rises. (of course the story would be worse for those who start college and do not finish.)
Note: typos were corrected and the comparison was clarified.
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According to a NYT piece, the food industry claims that people would not buy food if they knew it contained genetically modified organisms. The piece discussed a law passed by Vermont’s legislature that would require foods that contained genetically modified organisms to be labeled. It told readers:
“Big food manufacturers and the biotech industry that produces the seeds for genetically engineered crops contend that mandatory labeling of products containing ingredients derived from those crops — also known as genetically modified organisms, or G.M.O.s — will be tantamount to putting a skull-and-crossbones on them.”
Its striking that the industry apparently believes that it has to conceal information from the public in order to sell its products. Economists usually favor making information available to consumers so that they can make better choices.
According to a NYT piece, the food industry claims that people would not buy food if they knew it contained genetically modified organisms. The piece discussed a law passed by Vermont’s legislature that would require foods that contained genetically modified organisms to be labeled. It told readers:
“Big food manufacturers and the biotech industry that produces the seeds for genetically engineered crops contend that mandatory labeling of products containing ingredients derived from those crops — also known as genetically modified organisms, or G.M.O.s — will be tantamount to putting a skull-and-crossbones on them.”
Its striking that the industry apparently believes that it has to conceal information from the public in order to sell its products. Economists usually favor making information available to consumers so that they can make better choices.
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It’s a bit late, but who said the Washington Post can’t learn? It ran a nice piece on worksharing, pointing out the impact that reducing work hours can have in preventing unemployment. Those of us who have been working on worksharing for the last five years might be a bit frustrated with the delay, but if even the Washington Post can learn, there is hope for America.
It’s a bit late, but who said the Washington Post can’t learn? It ran a nice piece on worksharing, pointing out the impact that reducing work hours can have in preventing unemployment. Those of us who have been working on worksharing for the last five years might be a bit frustrated with the delay, but if even the Washington Post can learn, there is hope for America.
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Neil Irwin has an interesting piece in the NYT’s Upshot section about how housing is holding back the recovery. There are two points worth adding.
First, the vacancy rate continues to be well above historic averages. In the fourth quarter of 2013, the most recent period for which data are available, the vacancy rate was still over 10.0 percent. This compares to a vacancy rate that averaged less than 8.5 percent in the pre-bubble years. This translates into a large number of empty units that will discourage new construction for some time to come.
The other point is that looking at the historic average share of residential construction in GDP may be somewhat misleading. If we go back to the 1980s, the share of medical care in GDP has risen by more than 6.0 percentage points. This increase must come from other categories of consumption. If we say non-health care consumption is roughly 60 percent of GDP, then a 6 percentage point rise in the share of health care in GDP would imply a reduction of 10 percent in non-health care consumption, if the consumption share of GDP stayed constant.
In fact consumption has risen as a share of GDP, but if we assume the consumption share will not rise indefinitely, it means that a rising share of consumption going to health care means a smaller share going to everything else. The implication is that we might expect housing to comprise a smaller share of GDP going forward than in the past. In that story we should still expect housing to recover further, but perhaps not to its average share for 1970s, 1980s, and 1990s.
Neil Irwin has an interesting piece in the NYT’s Upshot section about how housing is holding back the recovery. There are two points worth adding.
First, the vacancy rate continues to be well above historic averages. In the fourth quarter of 2013, the most recent period for which data are available, the vacancy rate was still over 10.0 percent. This compares to a vacancy rate that averaged less than 8.5 percent in the pre-bubble years. This translates into a large number of empty units that will discourage new construction for some time to come.
The other point is that looking at the historic average share of residential construction in GDP may be somewhat misleading. If we go back to the 1980s, the share of medical care in GDP has risen by more than 6.0 percentage points. This increase must come from other categories of consumption. If we say non-health care consumption is roughly 60 percent of GDP, then a 6 percentage point rise in the share of health care in GDP would imply a reduction of 10 percent in non-health care consumption, if the consumption share of GDP stayed constant.
In fact consumption has risen as a share of GDP, but if we assume the consumption share will not rise indefinitely, it means that a rising share of consumption going to health care means a smaller share going to everything else. The implication is that we might expect housing to comprise a smaller share of GDP going forward than in the past. In that story we should still expect housing to recover further, but perhaps not to its average share for 1970s, 1980s, and 1990s.
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Eduardo Porter has an interesting column reporting the assessment of various experts on the prospective path of health care costs. Near the beginning he quotes a NYT reporter:
“Changes in the way doctors and hospitals are paid — how much and by whom — have begun to curb the steady rise of health care costs in the New York region, … Costs are still going up faster than overall inflation, but the annual rate of increase is the lowest in 21 years.”
Porter then goes on to tell us that the quote appeared in a column written by a long retired colleague in 1993.
Of course any hopes in 1993 that health care costs would be well-contained over the next two decades were mistaken, but things have turned out better than expected. A set of cost projections from the Health Care Financing Administration (the forerunner of the Centers for Medicare and Medicaid Services [CMS]) tells us the consensus view at the time.
These projections showed health care costing 19.8 percent of GDP in 2015 and 26.2 percent in 2040. The most recent projections from CMS show health care spending at 18.4 percent of GDP in 2015 and rising to 19.9 percent of GDP in 2022. The difference between the 1993 projection for 2015 and the most recent projection would come to more than $250 billion in 2015. If we assume a linear growth path between 2015 and 2040, the 1993 projections would imply that health care spending would be 21.6 percent of GDP in 2022, 1.7 percentage points higher than the most recent projections.
This difference is even more striking when considering the size of the projected changes over this period. Health care costs were already close to 13 percent of GDP in 1993. This means that the projection for 2015 implied an increase in costs of 6.8 percentage points. The most recent projections indicate the growth will be just 5.4 percentage points, a difference of more than 20 percent.
In short, the history of the last two decades indicates there was some basis for optimism about the future course of health care spending in 1993. It has risen substantially less rapidly than had been predicted at the time. For what it’s worth, life expectancy has actually increased somewhat more rapidly than projected, indicating that the lower than projected spending did not lead to worse health outcomes. On the other hand, the gains in life expectancy have not been evenly shared with those at the top end of the income distribution getting most of the increase and those at the bottom seeing little or no gain.
Note: A number was corrected and material added.
Eduardo Porter has an interesting column reporting the assessment of various experts on the prospective path of health care costs. Near the beginning he quotes a NYT reporter:
“Changes in the way doctors and hospitals are paid — how much and by whom — have begun to curb the steady rise of health care costs in the New York region, … Costs are still going up faster than overall inflation, but the annual rate of increase is the lowest in 21 years.”
Porter then goes on to tell us that the quote appeared in a column written by a long retired colleague in 1993.
Of course any hopes in 1993 that health care costs would be well-contained over the next two decades were mistaken, but things have turned out better than expected. A set of cost projections from the Health Care Financing Administration (the forerunner of the Centers for Medicare and Medicaid Services [CMS]) tells us the consensus view at the time.
These projections showed health care costing 19.8 percent of GDP in 2015 and 26.2 percent in 2040. The most recent projections from CMS show health care spending at 18.4 percent of GDP in 2015 and rising to 19.9 percent of GDP in 2022. The difference between the 1993 projection for 2015 and the most recent projection would come to more than $250 billion in 2015. If we assume a linear growth path between 2015 and 2040, the 1993 projections would imply that health care spending would be 21.6 percent of GDP in 2022, 1.7 percentage points higher than the most recent projections.
This difference is even more striking when considering the size of the projected changes over this period. Health care costs were already close to 13 percent of GDP in 1993. This means that the projection for 2015 implied an increase in costs of 6.8 percentage points. The most recent projections indicate the growth will be just 5.4 percentage points, a difference of more than 20 percent.
In short, the history of the last two decades indicates there was some basis for optimism about the future course of health care spending in 1993. It has risen substantially less rapidly than had been predicted at the time. For what it’s worth, life expectancy has actually increased somewhat more rapidly than projected, indicating that the lower than projected spending did not lead to worse health outcomes. On the other hand, the gains in life expectancy have not been evenly shared with those at the top end of the income distribution getting most of the increase and those at the bottom seeing little or no gain.
Note: A number was corrected and material added.
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