OK, I think Jeremy Siegal and Hassett have it figured out. Sid, please comment.
From knowledge.wharton.upenn.edu
Siegel: That?s accurate. But to get to your numbers, these long-term holders must be the ultimate pricers in the market. Let me now move to a related question. This is another difference between the Glassman-Hassett hypothesis and mine. The way you get your result is that you look at the pricing of long-term bonds and say that the stock market will move to the returns on bonds. While I agree that stocks have been underpriced through history, I also think that bonds have been overpriced. Instead of the real return on stocks going down to that of bonds, they will both come together at some real return that is in between the two. The real return on bonds is likely to rise and the real return on stocks will go down. I don?t think the gap will be eliminated, because I don?t think that long-term investors will control that market. But the gap will be closer. I think the real return on bonds will go up from the 1%-2% range to about 4%, and the real return on stocks will go down from 7% to about 5%. Given that, my feeling is that the market has already made a large move to that level. We see the price-earnings (P/E) ratio on the S&P 500 has risen to 30. Looking at the earnings yield on the market, I think lower yields are already being priced in to some extent. The current P/E ratio is 30, and since the historical average has been 14 or 15, we are twice as high as the average of the past 130 years.
Hassett: Your point that the bond rate should move up a little?so that you don?t go to Dow 36,000 but to Dow 22,000 or something like that?is reasonable. No one understands real interest rates well enough to rule that out. It is true that except for the last few months, there has been no discernible long-term trend in real interest rates. But there is a discernible long-term trend in the stock market. The stock market has been going up, while the interest rate has been fluctuating around in the 3% range as long as we have measured it.
I think Greenspan is thinking along the same lines as Siegal. The risk free lender has been pushing up rates. And as briefing.com says he'll continue to do so. Maybe up 1-2% over the course of the next few years.
Economists are always armed with a forecast of how much the Fed will ultimately have to raise rates -- 50 bp, 75 bp, etc. But here's an admission: we have no idea how far they will go
Lindsey mentions the fact that the stock market would add $25 trillion in "unjustified" new wealth if the Dow went to 36,000.
My friends Jim Glassman and Kevin Hassett have proposed the very provocative idea that a fair valuation of the Dow Jones Industrial Average is 36,000, not the current 11,000. We should all wish that they are right. Owners of American equities would be roughly $25 trillion richer...
Let's assume it doesn't get to 36,000, but to the above mentioned 22,000. That would make equity holders some $12 trillion richer. In the long term I don't believe in the tooth fairy, so where did the $12 trillion equity gain come from? It came from the debt holders who lost $12 trillion. As interest rates rise, debt (bond) prices are driven down.
So, maybe the people (CFOs) who are borrowing now to invest in the market (buy back stock) are acting rationally. The only factor that is out of alignment is the risk free loan rate. Uncle Sam has been giving borrowers a "free ride" Greenspan is taking care of that. |
