Opinion

Anatole Kaletsky

Markets: Exuberance is not always ‘irrational’

Anatole Kaletsky
Jul 25, 2014 19:17 UTC

A pedestrian holding his mobile phone walks past an electronic board showing the stock market indices of various countries outside a brokerage in Tokyo

With the stock market continuing to hit new highs almost daily despite the appalling geopolitical disasters and human tragedies unfolding in Ukraine, Gaza, Syria and Iraq, there has been much head-scratching about the baffling indifference among investors. Many economists and analysts see this apparent complacency as a symptom of a deeper malaise: an “irrational exuberance” that has pushed stock prices to absurdly overvalued levels.

The most celebrated proponent of this view is Robert Shiller, the Nobel Prize-winning, Yale University economist who is often credited with predicting both the 2000 stock market crash and the bursting of the U.S. housing bubble. Shiller may or may not have deserved a Nobel Prize for his academic work on behavioral economics but as a practical guide to investing, his approach has been thoroughly refuted by real-world experience.

Robert Shiller, one of three American scientists who won the 2013 economics Nobel prize, attends a press conference in New HavenShiller’s status as an investment guru owes much to the timing of his book “Irrational Exuberance,” published just days before the collapse of Internet and technology stocks in March 2000. What is less widely advertised, however, is that for decades, both before and after that predictive triumph, the stock market strategy implied by his analysis has turned out to be plain wrong.

Shiller’s argument that stock prices have been inflated to irrational levels is centered on a statistic called the cyclical adjusted price-earnings ratio, or the Shiller price-earnings ratio. Conventional price-earnings ratios divide the current level of share prices by the earnings estimated by analysts for the year ahead.

This ratio for the Standard & Poor’s 500 is now around 17. On this basis many conventional analysts, including Federal Reserve economists, conclude that U.S. stock prices are reasonably valued. A price-earnings ratio of 17 implies that if companies can sustain this level of profitability, they will provide investors with annual earnings of one-17th, or 5.9 percent, which compares favorably with long-term interest rates on government bonds of around 1 percent, after adjusting for inflation.

Karl Marx was right — at least about one thing

Anatole Kaletsky
Jul 11, 2014 18:42 UTC

 A board displays the Dow Jones industrials average after the close at the New York Stock Exchange

Confidence in the global economy is steadily improving, as shown in the financial markets’ bullish behavior and confident comments from companies and policymakers over the past few weeks. Though these columns have argued in favor of a robust recovery, when investors get uniformly bullish, the pessimistic case deserves attention.

Many distinguished economists believe that the current improvement in global conditions is just a blip. They insist that the world faces years, if not decades, of “secular stagnation.” How seriously should we take them?

The good news is that there is little evidence of secular stagnation in global statistics. The “new normal” for the world economy since 2008 has not been very different from the pre-crisis period. The average growth of the global economy from 1988 to 2007, the 20 years before the crisis, was 3.6 percent, according to the International Monetary Fund World Economic Outlook database. The IMF latest forecast for 2014 is exactly the same — 3.6 percent. Though Christine Lagarde, the IMF managing director, hinted at a modest downgrade this week.

How EU politics pushed Merkel to lift Germany’s austerity policies

Anatole Kaletsky
Jul 4, 2014 15:27 UTC

German Chancellor Merkel and Luxembourg's Prime Minister Juncker hold a joint news conference after a meeting in Luxembourg

Matteo Renzi, the prime minister of Italy who took the revolving presidency of the European Union this week, seems to be the sort of man that Napoleon was referring to when he reputedly said that the key qualification he sought in recruiting a general was good luck.

Renzi become prime minister without even needing to win an election because Silvio Berlusconi and all other rivals self-destructed. He took power just after Italy passed the lowest ebb of its economic fortunes. In May, he was rewarded for his good fortune by Italy’s voters, who anointed him with a strong democratic mandate in the same European elections that discredited almost all Europe’s other national leaders. Now he is taking the helm in Europe, as an economic recovery is starting and the European Central Bank is swinging decisively in support of growth.

But even a politician as lucky as Renzi could not have counted on his latest and most unexpected windfall: the unintended consequence of last week’s failed campaign by British Prime Minister David Cameron to stop the appointment of Jean-Claude Juncker as head of the European Commission.

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