Thursday, September 11, 2014

Asset Prices Outstripping Economic Growth

Two of my favorite charts (and I'm sure they're yours) is the S&P 500 PE ratio and dividend yield.  It is the basic comparison of what you're paying for a stock relative to what it pays you.

But every once in a while I like to go really macro and compare the country's economic growth to its asset prices.  In theory (bar international investments and trade) asset prices should not be increasing faster than economic growth in that all profits must come from economic growth.  Therefore, both asset prices and economic growth should grow at the same rate, otherwise we know there's either a bubble or a ('s been so long...what was it again we call stock markets that are!  That's right!) steal. 

So I took it upon my beleaguered economist ass to go and pull the data comparing the annual returns of the S&P 500 and subtracting out from it nominal economic growth which should in theory always be 0.

Heh, yeah right.

Naturally there's going to be oscillations and bubbles and troughs in any economy.  But given what we know about the PE ratio now being 70% higher than it should be, I just wanted another data set to view this from a different angle.  And this one didn't disappoint.

We see, during the economic crash, stock prices crashing even more sending the net difference between asset prices and economic growth into negative territory.  This meant asset prices were growing slower (crashing faster, actually) than economic growth was.  However, this only lasted one year (2008) and in 2009 where the economy contracted on a yearly basis by 2.9% the stock market punished this performance by awarding this slowing economy with a 25% increase in valuation.

This is like your kid coming home with straight F's and you increase their allowance by a a full fourth.

Since then the disconnect between economic growth and asset prices has continued as asset prices have averaged annual gains of 15% while the economy has managed just under 3%.

I'm going to say it again for the cheap seats and hope to god some future historian looks this up and sees it, but this is just another bit of proof that Americans are more interested in baloney asset bubbles than they are actual economic growth.  It is the modern day epitome of American psychology where we want all of the rewards, but without having to expend any of the work.

Does it matter that stock prices are being driven by retirement dollars and not profits?
Does it matter that equities are being driven by QE and low interest rate monetary policies which prompt corporate buy backs?
Does it matter economic potential in this country is so low corporations would rather buy back shares than invest and create jobs?

No, because prices are up and that's our super happy fun juice!

I know the federal reserve is powerful and that the world economy is already structured around a US dollar reserve currency.  But neither are more powerful than the forces of math and reality.  I just hope to see that reality manifested before I die.  In the meantime, Enjoy that Decline!


Kristophr said...

The Dollar will not last forever as a reserve currency.

FATCA and Russian trade sanctions are driving other countries away from the dollar. The BRICS are setting up a system to rival SWIFT.

When the dollar is thrown from its reserve status perch by Washington's dumbassery, all those trillions of dollars will come home to the US, since no one else will accept them. And all that inflation we have exported will come home.

Armchair Observer said...

Watch the S&P and the US dollar rise relentlessly for at least a year.
Capital flow ...low foreign interest rates.. retail invwstor not in yet .. and geopolitical unrest If everyonesvon one side of the bet , u can be sure it will do the opposite.

Goodtimez said...

Asset prices can grow faster than GDP

The reason is, in short, because not everyone is "buy and hold". Put another way, it's because the amount of investment varies.

Put another way, and pay attention to this one, the average return to people investing in the S&P500 is less than the actual S&P500 return. How is this possible? It's because when the market is down, people withdraw. When the market is up, more people buy in.

Fewer people ride the up waves, and more people ride the down waves. Read the article -- he explains it more eloquently.

Here is my favorite article on the subject:

Here are some of his basic points:

1) GDP growth and stock market returns do not have any particularly obvious relationship, either empirically or in theory.

2) Stock market returns can be significantly higher than GDP growth in perpetuity without leading to any economic absurdities.

3) The most plausible reason to expect a substantial equity risk premium going forward is the extremely inconvenient times that equity markets tend to lose investors’ money.

4) The only time it is rational to expect that equities will give their long-term risk premium is when the pricing of the stock market gives enough cash flow to shareholders to fund that return.

Captain Capitalism said...


You earn a Cappy Cap Gold Star.

Outstanding observation!