Putting stock in the market

August 18, 2014

Robert Shiller wants us to talk about stock prices. “We are in an unusual period, and that it’s time to ask some serious questions about it,” he says.  Specifically, Shiller wants to discuss just how far above normal they currently are:

The CAPE [cyclically adjusted price-earnings ] ratio, a stock-price measure I helped develop — is hovering at a worrisome level… It is above 25, a level that has been surpassed since 1881 in only three previous periods: the years clustered around 1929, 1999 and 2007. Major market drops followed those peaks.

That measure of stock price valuation has, Shiller writes, moved all over the place, “yet it has consistently reverted to its historical mean” of just over 15. (If you prefer purely anecdotal signs of effervescence, those exist too. Actor Jared Leto has become aventure capitalist and NBA All Star Carmelo Anthony is becoming a tech investor.) Shiller tries, but can’t quite come up with a good, fundamental reason why the market should be so elevated.

In May, the NYT’s David Leonhardt pointed to a plausible, if unsettling basis for high valuations: “Despite the mediocre economy, corporate profits are fairly strong, because companies have the upper hand on workers today and wage growth is modest. Inequality, in other words, tends to be good for stocks.” His colleague Neil Irwin wrote in July that it’s not just stocks that are on a tear. Everything – real estate, bonds, etc. – is booming and/or bubbling. Accurate as that is, it is a description, not a justification.

Brad DeLong looks at whether you should really worry too much about the market being too high. Over a ten-year investment horizon, stocks are almost always a winner. DeLong charts cumulative returns on stocks and finds “the dominant feature is not mean reversion but rather exponential growth.”

Dean Baker tries to take a middle ground, arguing that stocks are still a “pretty good deal,” and will continue to be so “even if there is some decline in the profit share of income and also some reversion toward long-term trends in price to earnings ratios.” Baker’s conclusion is sort of comforting for the stock-owning: even if things get a little worse, they’ll be far from bad. — Ben Walsh

On to today’s links:

Financial Innovation
An update on Fantex, the company that let’s you buy equity in athletes (sort of) – Sujeet Indap

Good Internet
The outlaw Instagrammers of New York City – Adrian Chen

The theory behind the universal basic income – Ed Dolan

Home renting scams proliferate on AirBnB competitor HomeAway – BuzzFeed

Food insecurity is a huge problem among students — most of whom are too proud to admit it – Ned Resnikoff

Niche Markets
The biggest business in the Bridal Veil, Oregon – Katie Baker

Skipping subway fare has become one of the most common reasons for incarceration in NYC – Daily News

Facebook wants to label The Onion links as “satire” – The Guardian

Ferguson and growing suburban poverty – Brookings

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