Bob and All: Applegate's take on the market:
Headline: U.S. Investment Strategy: What Bubble? Author: Jeffrey M. Applegate 1(212)526-4585 Company: Country: MKT CUS Industry: NOINDU Today's Date : 05/27/98 * Now, as in the 1960's we have sensibly run monetary and fiscal policy, low inflation and interest rates, a low equity risk premium, good labor productivity, a recurrent deflationary positive supply shock from technology, and strong capacity creation.
* In the 1990's they have been joined by steadily rising profit margins and profit growth, globalization of capital and labor markets, deregulation of industries globally and the end of the Cold War.
* Accordingly, if the stock market is a discount mechanism, it should be discounting an unprecedented confluence of events. Ergo, valuation records should be exceeded. That is not a bubble.
* There is no bubble in other asset classes real estate, gold, oil or other commodities as well
What Bubble? Will the Federal Reserve hike interest rates to prick the so-called U.S. stock market bubble? We don't think so. Should they? No. Herewith is our attempt to rebut the assertion that there's a bubble in U.S. stock prices. While there's no precise definition of what constitutes a bubble, from first principles, most people would broadly agree that it is a level of prices unsupported by the fundamentals. We have repeatedly made the point that the U.S. economy of the late 1990s most closely resembles the U.S. economy of the early to mid-1960s. This is the first period since then that all of the following are in place: sensibly run monetary and fiscal policy, low inflation and interest rates, a low equity risk premium, good labor productivity, a recurrent deflationary positive supply shock from technology, and strong capacity creation. Additionally, some other rather important things are extant that weren't thirty years ago: steadily rising profit margins and profit growth, globalization of capital and labor markets, deregulation of industries globally, a bigger recurrent deflationary positive supply shock from technology, and the end of the Cold War. All of these things have never been in place at the same time. Accordingly, if the stock market is a discount mechanism, it should be discounting an unprecedented confluence of events. Ergo, valuation records should be exceeded. Which is, of course, what's been happening. We would submit that it would be illogical for the stock market to be priced differently given the fundamentals. Thus, unlike some observers, we see no bubble here. Bubble proponents say the Federal Reserve needs to deflate the stock market by raising interest rates, implying that the Fed has a credibility problem if it fails to do so. We would submit that the credibility risk lies with the bubble proponents, not the Fed. For the central bank to get truly exercised about this so-called bubble, there ought to be some proof in the pudding: i.e., some transmission of this asset bubble the wealth effect into consumer spending or other assets. However, during this business cycle, consumption has grown in-line with income, at a respective 5.2% and 5.3% annual average rate; year over year, consumption is actually lagging income, 4.4% versus 5.6%. Moreover, the U.S. household balance sheet has not gotten more leveraged since 1990 (see U.S Balance Sheet Checkup, U.S. Strategy, April 27, 1998). There is just no discernable transmission of any wealth effect into outsized consumer spending or leverage. There is also no evidence that households are outsized users of margin debt to purchase stocks. The level of margin debt is at a record high, $140 billion. But so too is the stock market. So margin debt, as a share of equity outstanding, is only 1.1%, hardly an alarming level. Also, despite the chatter that U.S. household ownership of equities has exploded in the 1990s, the data doesn't support that conclusion. Our Political Economist, Tom Gallagher, has provided us with the data from theFederal Reserve's Survey of Consumer Finances: the percent of households owning publicly-traded equities directly, in mutual fund format and in defined contribution retirement plans, was 41% in 1995. In 1983, the year before Congress enacted 401(k) legislation, the figure was 33%. So it has risen considerably since the 401(k) was created. But, have U.S. households gone nuts over stocks? No. If there is no discernable wealth effect on U.S. households as a result of the so-called stock market bubble, what about other asset classes? One obvious candidate would be residential real estate. Some of the bubble proponents live in the New York metropolitan area where housing prices are quite robust. But nationally, residential real estate values are up a mere 16% cumulatively since 1990; last year they were down 0.2%. No wealth effect here. Ditto for commercial real estate. Those values, as measured by the National Council of Real Estate Investment Fiduciaries (NCREIF) appreciation index, are down 3.9% on an annual average basis since 1990; last year, it was up 4.4%. No bubble here either. Finally, try if you can to find asset price inflation in commodities. Apart from gold which is up 4% this year after falling 22% in 1997 oil and all the major commodity indices (even those in SDRs) are down year over year and year to date. So, bubble proponents, just because Bill Gates pays a record $30 million for a Winslow Homer doesn't mean we have a generalized wealth effect or inflation problem. There's simply no stock market bubble for the federal reserve to deflate.
----------------------------------------------------------------------------- Disclosure Legend: A-Lehman Brothers Inc. managed or co-managed within the past three years a public offering of securities for this company. B-An employee of Lehman Brothers Inc. is a director of this company. C-Lehman Brothers Inc. makes a market in the securities of this company. G-The Lehman Brothers analyst who covers this company also has position in its securities. |
