I just read the article and consider the argument flawed to its very core. It is like reading Marxist theory, in which everything is internally consistent, but based on bogus axioms and therefore horribly wrong.
I just posted a critique of the article as an off-thread comment on one of the Yahoo boards I frequent:
...The authors criticize the old way of valuing stocks, and come up with a new valuation technique that they say is more reasonable, and thus conclude that the market could be much, much higher, and still not overvalued.
The problem is that anyone just looking at valuation methods of any kind is forgetting about the REAL connection between the market and the
economy. Stock price levels represent the cost of capital to companies. The higher stock prices go, the lower that cost of capital, and the easier it
is to raise equity capital - IPOs, and additional offerings from companies already public.
On its way to DJIA 36,000 two things would happen: 1)more and more companies would float stock, and the supply of shares (which can
expand infinitely - see the internut stocks) would overwhelm the demand and prevent 36,000 and 2)money raised in these offerings would expand
capacity and cause business competition to overwhelm demand, reducing or eliminating profit margins in those industries where too much capital
has been raised (again, see the internuts, where almost everything is priced at zero these days.)
The stock market, more than anything else, is a communications system. Rising stock prices are a message to invest more. When we have ample
capacity, and profit margins have peaked, the market sends a new message: we have enough capacity now, thank you, it is not wise to finance yet
more competition. Its language? A bear market. And the bear market continues until enough competitors and capacity have been wiped out to
bring supply and demand back in balance. [end of Yahoo post]
Since one can write much longer SI posts, I'll put what I am saying in Glassman and Hassett's terms: The higher stock prices go, the more competition will increase in most industries, because of the ease with which competitors can raise capital in a booming stock market. As these businesses vie for the limited demand, price wars will cause profit margins to shrink and take away the rising profit growth, and probably the profits altogether, that is the basis for the 36000 valuation.
Why hasn't this happened already? Why are profit margins very high despite the rising market we have had to date? Because the process of raising money and expanding capacity first increases demand in the economy, and only later increases supply.
For example, a company with a hot e-commerce concept goes public, with investors throwing money at it. It hires engineers, marketing people, etc., it buys computers, servers, it rents space, buys furniture, etc. All the employees and the companies selling stuff to this new company now have more money in their pockets and they spend it, etc., boosting the economy.
But at some point our little start-up has to turn into the black, or it will run out of its original nest-egg, lay off its employees, etc. And our company is one more competitor out there trying to grab the e-commerce dollar, making life a little tougher, and the possibility of future profits a little more remote, for its competitors.
The economy has benefited for the last several years from the spending by companies of equity money they have raised. In fact, since the total of equity offerings has been running at about 2% of GDP for several years, it is possible that that has been the ONLY real stimulant to demand, and that if the DJIA were still at 4000 for some psychological reason, we would not yet have gotten out of the early 1990's recession. This is the real "wealth effect" of the stock market, more than people feeling rich and buying cars.
Let the market go down, either for random reasons or because of people anticipating the impact on margins of all the competition we have just financed, and that sets off a downward spiral where the market and the real economy interactively bring each other down, the opposite of what we have had for many years.
Near the bottom, watch for a follow up book "Dow 3600". |
