Blog Post

Blogs review: The stock market recovery

What’s at stake: The strengthening of the U.S. economy was reflected last week by a positive jobs report with America adding 236,000 more jobs in February than it had in January, and an unemployment rate down to 7.7%. The past week was also marked by new highs in stock market valuations, which generated discussions about the sustainability of these improvements, the role of monetary policy in driving equity prices and the impact of stock market valuations on the rebuilding of household balance sheets.

By: Date: March 11, 2013

What’s at stake: The strengthening of the U.S. economy was reflected last week by a positive jobs report with America adding 236,000 more jobs in February than it had in January, and an unemployment rate down to 7.7%. The past week was also marked by new highs in stock market valuations, which generated discussions about the sustainability of these improvements, the role of monetary policy in driving equity prices and the impact of stock market valuations on the rebuilding of household balance sheets.

The stock market in a historical perspective

Ryan Avent writes that there is no denying that equities are having a good run. True, the press reports have mostly focused on the Dow, which is not the best-constructed index, is not a one-stop shop for assessments of the American economy. And yes, adjustments for inflation and dividends leave a slightly different picture of where the Dow is relative to past levels. But, as noted in the print edition of The Economist, Wall Street is not alone. Stock markets in the developed world have been in fairly buoyant mood since the start of the year with the MSCI World Index rising by 5% in the first two months of 2013, and the Japanese market gaining 13.5%. Emerging markets, in contrast, have been flat.

Source: Gavyn Davies

Justin Lahart (HT Mark Thoma) notes in the Wall Street Journal that with dividends reinvested, the Dow would now be at 16,600. Adjusting for both inflation and dividends would put the Dow industrials around 15,000.

What will come next

Gavyn Davies writes that investors are naturally very focused on whether equities, having failed twice before to break above current levels, can finally overcome vertigo and sustain a bull run into unprecedented territory.

Neil Irwin notes that the last time the S&P lodged a four-year gain as strong as the current run was from late 1996 to late 2000, which was, with hindsight, a time of an epic bubble. Given that the current market boom has been fueled in no small part by easy money policies out of the Federal Reserve, there’s some simmering worry that this too is a bubble—perhaps that the minute the Fed starts inching away from the era of cheap money, the whole thing will collapse in upon itself. But there’s good evidence pointing to this not being the case. The key thing to know is that American businesses have spent the last four years becoming much more profitable.

Robert Shiller sends us to an index that he has developed with colleagues at the Yale school of management. It is the percentage of respondents who think that the stock market is not overvalued. Using the six-month moving average ended in February, it was running at 72 percent for institutional investors and 62 percent for individuals. That may sound like a ton of confidence, but it isn’t as high as the roughly 80 percent recorded in both categories just before the market peak of 2007.

Source: Yale School of Management

Robert Shiller uses a measure of stock market valuation that he developed more than 20 years ago with Prof. John Campbell of Harvard, called the cyclically adjusted price-earnings ratio, or CAPE. It measures the real, or inflation-adjusted, Standard & Poor’s 500 index divided by a 10-year average of real S.& P. earnings. The CAPE has been high of late: it stands at 23, compared with a historical average of around 15. This suggests that the market is somewhat overpriced and might show below-average returns in the future.

The print edition of The Economist notes that an alternative measure, the Q ratio, which compares shares to the replacement cost of net assets, shows the American market as 50% overvalued, according to Smithers & Co, a consultancy.

Monetary policy and the search for yield

Neil Irwin writes that the S&P is yielding 6.7 percent right now (this is just 1 over a P/E ratio of 14.8). Now compare that yield of 6.7 percent to what a risk-free asset is paying right now. For 10-year Treasury bonds, that’s 1.8 percent. The gap between those two numbers, nearly 5 percentage points, is, in effect, the extra compensation investors receive for investing in risky stocks instead of safe bonds. For comparison, look at what that same gap (the equity risk premium, to use the finance geek term) has been at some other key moments. In the summer of 2007, the stock market earnings yield was 5.8 percent, lower than it is now, though not drastically so. Yet at the time, 10 year Treasury bonds were yielding 5.1 percent. And the current boom has almost nothing in common with the bubble that ended in March 2000. At the peak of that boom, the S&P had an unprecedented price to earnings ratio of 31.4, which translates into a 3.2 percent earnings yield. At the time, Treasuries were yielding 6 percent.

Source: Gavyn Davies

Mark Thoma writes that the policy of the Fed has created an increase in demand that has helped to drive up stock and bond prices. In addition, monetary policy has helped to boost the economy, in part through greater spending induced by this "wealth effect" from higher asset prices, and this has a feedback effect that further increases asset prices.

The stock market and the real economy

Yih Lin Teh and John Hawksworth note at the PwC blog that, from November 2012 to the end of January 2013, major stock markets experienced relatively strong gains – in marked contrast to negative GDP growth in most of the major advanced economies in Q4 2012.

Paul Krugman writes that the high level of stock prices is, in large part, a reflection of the growing disconnect between productivity and wages. While the economy remains deeply depressed, corporate profits have staged a strong recovery. Not only are workers failing to share in the fruits of their own rising productivity, hundreds of billions of dollars are piling up in the treasuries of corporations that, facing weak consumer demand, see no reason to put those dollars to work.

Mark Thoma the relationship between the stock market and the economy is not very reliable and stock market values only explain a small proportion of the total movement in variables like GDP and employment. Thus, while it’s very likely that the recovery will continue at its slow pace, that prediction has little to do with recent movements in stock prices.

The improvement in household balance sheets

Neil Irwin writes at the Wonkblog that the rise in the stock market is a major, major reason that Americans’ household finances are looking better. Stock investments and mutual funds only amount to about 20 percent of Americans’ assets, according to data from the Federal Reserve; much more of their money is tied up in their houses, other physical assets like cars, bank accounts, life insurance policies, and the like. Yet between 2008 and the third quarter of 2012, they accounted for 59 percent of the $10.6 trillion rise in American households’ assets. Americans—at least those with significant savings—are feeling wealthier, and the booming market is a big part of the reason. Household real estate, by contrast, is still worth less than it was in 2008 even after edging up recently.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Topics

Tags

Comments

Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

Blaming the Fed for the Great Recession

What’s at stake: Following an article in the New York Times by David Beckworth and Ramesh Ponnuru, the conversation on the blogosphere was dominated this week by the question of whether the Fed actually caused the Great Recession. While not mainstream, this narrative recently received a boost as Ted Cruz, a Republican candidate for the White House, championed it.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: February 1, 2016
Read article More on this topic

Blog Post

IMG_20151009_103117 (3)
Pia Hüttl

Lost in assumptions: assessing the economic impact of migrants

What’s at stake: Many research institutes have estimated the economic impact of migrants, in particular regarding fiscal budgets and the labour market. These studies often give contradictory results. This blogs review looks at the different assumptions and approaches behind these results.

By: Nuria Boot and Pia Hüttl Topic: European Macroeconomics & Governance Date: January 18, 2016
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The use of models by policymakers

What’s at stake: The latest discussions on the blogosphere have been dominated by a back and forth trialogue between Larry Summers, Paul Krugman and Brad DeLong on the appropriate use of models as policy guides. While they all agree that the Fed’s decision to raise rates was a mistake, they disagree on the intellectual reasons behind it.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: January 11, 2016
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

Finland and asymmetric shocks

What’s at stake: Finland exemplifies the difficulty of dealing with asymmetric shocks within a Monetary Union as the Finnish economy has struggled to recover from a series of idiosyncratic shocks – the decline of Nokia, the obsolescence of the timber industry, and the fallout of the Russian crisis.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: December 21, 2015
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The predictability of political extremism

What’s at stake: The rise of the extreme right in the latest French election has mostly been treated as surprising or reflecting special circumstances like the November 13 Paris attacks. But a large literature linking extreme right votes to persisting depressed economic conditions suggests that longer run factors are at play.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: December 14, 2015
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The puzzle of technical dis-employment and productivity slowdown

What’s at stake: Larry Summers made an important speech a few weeks ago at a Peterson Institute conference on the productivity slowdown arguing it is hard to see how recent technical change could both be a major source of dis-employment and not be associated with productivity improvement.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: December 7, 2015
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

Unlearning economic paradigms

What’s at stake: Both the crisis, its aftermath, and the empirical econ revolution have changed our understanding of economics. Conventional wisdoms about the supply side of the economy, the length of the short run, or the international adjustment process are all being challenged. Even conventional microeconomic wisdoms about the role of minimum wages and welfare programs are being challenged by new data raising questions about how economics should be taught and used to guide policymaking.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: November 30, 2015
Read article More on this topic More by this author

Blog Post

augustin_lagarde

The economic debates behind COP21

What’s at stake: France will chair and host the 21st Conference of the Parties to the United Nations Framework Convention on Climate Change (COP21) at the end of the year. While the scientific community has reached a consensus that climate-warming trends are very likely due to human activities, the discussion about how to address is mired in huge political disagreements.

By: Augustin Lagarde Topic: Energy & Climate Date: November 23, 2015
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The persistence of slow growth

What’s at stake: The persistence of slow economic growth in the Great Recession has been puzzling. Two recent papers have tried to present a coherent framework for understanding this phenomenon. The first paper argues that we may have underestimated the importance of hysterisis effects. The second paper argues the global safe asset shortage cannot be resolved by lower world interest rates once we reach the zero lower bound. It is instead dissipated by a world recession that rebalances global asset markets.

By: Jérémie Cohen-Setton Topic: Global Economics & Governance Date: November 16, 2015
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The uncertain decline of the natural rate of interest

What’s at stake: Controversies over whether and by how much the natural rate of interest – the rate compatible with full employment and stable prices – has declined in the past few years has shaped views about the pace and extent to which central banks should normalize policy rates.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: November 9, 2015
Read article More by this author

Blog Post

Jérémie Cohen-Setton

QE and investment

What’s at stake: Quantitative Easing has been criticized for generating inflation risks, financial stability risks, and distributional risks. The newest criticism from Kevin Warsh, a former Fed Governor, and the 2001 Nobel Prize laureate Michael Spence is that QE actually reduced investment!

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance, Global Economics & Governance Date: November 2, 2015
Read article More on this topic

Blog Post

Uuriintuya Batsaikhan
Pia Hüttl

The global debt overhang

What’s at stake: Seven years after the financial crisis, recovery is still weak in most parts of the global economy. The general debt overhang across sectors, which was not reduced in the last years, has often been cited as as the main factor weighing on global growth and inflation.

By: Uuriintuya Batsaikhan and Pia Hüttl Topic: Global Economics & Governance Date: October 26, 2015
Load more posts