I heard that the link doesn't go straight to the story, so here it is:
Reality Test
Exploring the Reasons Behind the Bubble
By Ben Stein
Special to TheStreet.com
01/02/2002 10:04 AM EST
URL: thestreet.com
All right, let's try a new approach.
By any historical standard, we are in a bubble:
Stock prices as a ratio to earnings are uniquely high.
Stock earnings as a percentage of price are uniquely high.
No earnings growth within the context of historical precedent could occur that would rationalize the current broader-market stock prices -- in terms of bringing them within the historical levels of the postwar period within the next few years, even without any further growth in stock prices.
Stock yields as earnings have come to fall greatly below the yields of bonds or real estate, by amounts that are unique except in other bubble periods.
Stock yields in terms of dividends have become frighteningly small except in rare cases as compared with earnings on other long-term investments.
We know all of this for sure, and I have demonstrated it with numbers repeatedly. Now the question is, why do we have a bubble? Here are a few possible answers:
Generalized innocence and lack of knowledge about the realistic potential of the stock market. This would include innocence about how much earnings can go up for the whole market in a year or two. I see this daily in letters from kind, well-meaning and obviously intelligent investors who genuinely believe that corporate earnings might double or triple within a year or 18 months. That mindset is the same one that pushed Internet companies to stratospheric levels and commanded that millions of miles of fiber-optic cable be laid without any use for it. This is pure bubble thinking, and it's utterly seductive. I've been seduced by it in the past and probably will be again. Nevertheless, it is still bubble thinking.
Investors who believe that a stock price should not be related to earnings but only to more emotional feelings about the stock's value, without applying any numbers to it. This is the exact kind of thinking that created the Tulip Bubble, in which prices were determined by beauty and hope, not by any regard to possible future earnings. This is also what drove the Japanese stock and real estate bubbles that Japan still suffers from. Again, this is pure bubble thinking on the way up, and pure crash feeling on the way down.
A genuine economic phenomenon of excess liquidity chasing too few stocks. Economists know -- or used to know -- that, in Milton Friedman's words, "Inflation is always and everywhere a monetary phenomenon." The inflation in stock prices in the late '90s, now getting replayed, may well be the result of very rapid monetary growth. This growth, intended by some of the most well-intentioned and thoughtful men and women, did not create wage or price inflation, perhaps because of worldwide ability to supply goods, perhaps because of a frightened labor force after the severe recessions of 1981 and 1992. But it might have created a classic inflation of too much money chasing too few stocks, which led to the stock run-up in the late '90s, the crash as the Fed clamped down on money supply and raised rates in 1999 and 2000, and now the new bubble as money is created at (sort-of) rapid rates and short-term interest rates fall dramatically.
These are all possible explanations. There's also the scenario of baby boomers attempting to buy stock for retirement and bidding up prices ridiculously, although this is really the same as items 1 and 2 -- bidding up securities without regard to their earnings.
What do all of these have in common? They will all end if history is any guide.
All periods of speculation when stock yields fall drastically below bond yields end in tears. I have no idea when the tears will come, and I make no predictions at all about tomorrow, next week or next year. But in time, the tears will flow as investors wake up one morning and want yield.
All periods of speculative bubble -- when investors buy stocks with no regard for their yields, only because of vague feelings that the stock has momentum or that it's a must-have stock or that it's in a high-growth area -- end in severe corrections, or have so far.
And all periods of excess liquidity also end. Monetary policy, as Fed Chairman Alan Greenspan often points out, is a highly imperfect instrument. Sometimes it's too tight and sometimes it's too loose. But it never stays too loose forever.
At some point, when that big profits recovery the market is looking for kicks in, Greenspan and his pals will start to raise rates and drain money from the system. Then bond yields will rise even more than they recently have, and investors will get spooked -- if history is any precedent. The market rarely can resist the Fed for long, and maybe it never can. If Greenspan truly believes the economy has recovered and he needs to tamp down irrational exuberance and keep another billion miles of fiber from being laid, he can do it. And he will.
Or, to put it in a way that my late, brilliant father once said to me, "Bubbles are just another form of hyperinflation, and there is one common factor in all hyperinflations. They all end."
I don't know when and I don't know by how much, but they all end.
--------------------------------------------------------------------------------
Benjamin J. Stein has been a trial lawyer, a White House speechwriter for former Presidents Nixon and Ford and a campaign speechwriter for Reagan. He has been a columnist for The Wall Street Journal and written for publications including Barron's, New York magazine and Los Angeles magazine. He is a novelist, a nonfiction book writer and a screenwriter, and he has been an expert witness on financial fraud. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. At time of publication, Stein had no positions in any of the securities mentioned in this column, although positions can change at any time. While Stein cannot provide investment advice or recommendations, he invites you to send your feedback to Ben Stein. |
