Needless to say, I agree with Lindsey, not G&H. His pointing out that expectations of high stock market returns puts upward pressure on interest rates and downward pressure on consumption, both of which hurt corporate profits, is exactly the sort of understanding of the relationship between the stock market and the real world that G&H (and also Siegel and other followers of academic finance orthodoxy) fail to understand.
Lindsey points out that rising leverage has pushed the market higher, and I read an interesting analysis from Briefing.com a few weeks ago that backs that up. Based on figures from Freddie Mac, the average homeowner ten years ago had $65,000 worth of equity in his home. Over the last ten years house prices are up 50%. So between rising prices and paying down mortgages over time, equity should be way up, right? Well, the current figure is actually $55,000 which means that people have borrowed all the appreciation in their houses, and then some. Briefing.com calculated that represents about $4 trillion in extra debt (can't remember the exact number, but something like that.) OK, so there are probably a good trillion dollars worth of SUVs driving around, but the rest was probably put into the stock market, a noticeable amount of its $22 trillion or so market cap. How much more can we expect from that trend?
One other point: Break apart the tremendous increase in the market in the last decade, and you could describe it this way: Stock prices have been rising faster than earnings, and earnings have been rising faster than sales. G&H focuses on the first half of that sentence, describing it in terms of the reduced risk preference, but let's look at the second half. Unless the New Economy has repealed elementary arithmetic, last I checked there were only 100 cents in the dollar. There is a limit to how many of them can go to profits, and that ratio is now the highest in history. How much higher can profit margins grow? If they stabilize here, then profits will grow only as fast as sales, at most 6% in a booming economy. If because of rising labor and interest costs margins start dropping, then one will have to count entirely on ever rising P/E's to keep the market even. |
