Is the current monetary, tax and regulatory policy leading us into another bubble in the stock market?
Robert Shiller, a Nobel price winner in economics is among the few professional stock market analysts who I admire the most and whose work I follow always. I got to know about him a couple of years ago when I was convinced that corporate stocks in the market were being over-valued. Most of the people who disagreed with me based their arguments on the price earning ratios which were in agreement with the applicable historical averages. Price/earning ratio is where the price of a company’s stock is divided by the annual earnings of the same company.
I believed that the prices of stocks were exaggerated, which is still the case today, but because the price/earning ratio was religiously followed, and then it was hard for me to put forth a persuasive case. Then something awesome happened-I discovered Shiller’s work. The analysis which is presented by Shiller is based on the price of the stock against long term earnings but not annual earnings of the company. He clearly argues that a financial year is too short to determine whether a stock is underpriced or overpriced. To most people, this makes sense! Factors such as economic situation, accounting adjustments and failure or success of a new product launch are just a few factors that could distort the price/earning ratio of a stock.
But when the price of the stock is divided by long term earnings, these distortions are corrected and as of today, this technique can be used to determine of the price of a stock is high or low.
The only times which times P/(l-t) have been very high is during the 1929 stock crash, the bubble burst of 2000 and the financial crisis which was experienced in 2008. A combination of several economic forces are pushing stock prices to unsustainable heights and among them include such things as low interest rates, labor-cost inflation and low commodity prices. All these prices help to increase the amount of profits registered by corporate, therefore pushing stock prices upwards.
But there is another powerful force which is normally overlooked by many people and which is mostly responsible for the high stock prices in today’s economies: the easy monetary policies put in place by the Federal Reserve. One thing that points to this is the five and half years-of – quantitative-easing, popularly known as QE. The threat posed by high inflation level is what worries most QE advocates. Personally, inflation does not worry me much. For five years now, we have been told repeatedly that QE will spark a rise in inflation, but there is no sign of it in today’s word.
Because the QE policy developed by the Federal Reserve is unprecedented, we may be experience some inflation some years down the line. But for now, inflation ranks low in the list of our worries today. What gets me worried is the huge amount of money that QE has driven into the stock market by lowering the interest rates so that it becomes affordable for potential investors. Investors have adopted stocks investment by large numbers and accepted the high risks associated with this kind of investment.
Other factors that have added to the huge stock market investments include the rising after tax incomes received by investors, minimal capital gains tax and many more. But because the regulator of the financial markets have been gutted for the last two decades and the failure by the authorities to hold anyone responsible for abuses have brought down the protection which we depended on for the last 70 years.
As I wrote in my previous articles, Gold, as one of the superb wealth insurance methods helps protect you in hard times by helping in offsetting losses in your portfolio. In the seven periods where economic turmoil was experienced in the last 25 years, Gold has registered great performance and has outperformed a wide range of other asset classes. One of the notable periods where gold stood out against other investments is during the 2008-2009 financial crisis. I do believe that we are creating some conditions which will cause us a severe economic crisis than what we experienced during the 2008-2009 period. Without doubt, this was the worst economic burst since the great depression.
Robert Shiller, a Nobel price winner in economics is among the few professional stock market analysts who I admire the most and whose work I follow always. I got to know about him a couple of years ago when I was convinced that corporate stocks in the market were being over-valued. Most of the people who disagreed with me based their arguments on the price earning ratios which were in agreement with the applicable historical averages. Price/earning ratio is where the price of a company’s stock is divided by the annual earnings of the same company.
I believed that the prices of stocks were exaggerated, which is still the case today, but because the price/earning ratio was religiously followed, and then it was hard for me to put forth a persuasive case. Then something awesome happened-I discovered Shiller’s work. The analysis which is presented by Shiller is based on the price of the stock against long term earnings but not annual earnings of the company. He clearly argues that a financial year is too short to determine whether a stock is underpriced or overpriced. To most people, this makes sense! Factors such as economic situation, accounting adjustments and failure or success of a new product launch are just a few factors that could distort the price/earning ratio of a stock.
But when the price of the stock is divided by long term earnings, these distortions are corrected and as of today, this technique can be used to determine of the price of a stock is high or low.
The only times which times P/(l-t) have been very high is during the 1929 stock crash, the bubble burst of 2000 and the financial crisis which was experienced in 2008. A combination of several economic forces are pushing stock prices to unsustainable heights and among them include such things as low interest rates, labor-cost inflation and low commodity prices. All these prices help to increase the amount of profits registered by corporate, therefore pushing stock prices upwards.
But there is another powerful force which is normally overlooked by many people and which is mostly responsible for the high stock prices in today’s economies: the easy monetary policies put in place by the Federal Reserve. One thing that points to this is the five and half years-of – quantitative-easing, popularly known as QE. The threat posed by high inflation level is what worries most QE advocates. Personally, inflation does not worry me much. For five years now, we have been told repeatedly that QE will spark a rise in inflation, but there is no sign of it in today’s word.
Because the QE policy developed by the Federal Reserve is unprecedented, we may be experience some inflation some years down the line. But for now, inflation ranks low in the list of our worries today. What gets me worried is the huge amount of money that QE has driven into the stock market by lowering the interest rates so that it becomes affordable for potential investors. Investors have adopted stocks investment by large numbers and accepted the high risks associated with this kind of investment.
Other factors that have added to the huge stock market investments include the rising after tax incomes received by investors, minimal capital gains tax and many more. But because the regulator of the financial markets have been gutted for the last two decades and the failure by the authorities to hold anyone responsible for abuses have brought down the protection which we depended on for the last 70 years.
As I wrote in my previous articles, Gold, as one of the superb wealth insurance methods helps protect you in hard times by helping in offsetting losses in your portfolio. In the seven periods where economic turmoil was experienced in the last 25 years, Gold has registered great performance and has outperformed a wide range of other asset classes. One of the notable periods where gold stood out against other investments is during the 2008-2009 financial crisis. I do believe that we are creating some conditions which will cause us a severe economic crisis than what we experienced during the 2008-2009 period. Without doubt, this was the worst economic burst since the great depression.