Post by unlawflcombatnt on Jul 18, 2007 13:59:53 GMT -6
Here's an excellent assessment of the recent stock market gains from the International Herald Tribune, written by David Leonhardt. The title of the article is
The illusion of investment profits.
Below are excerpts from the article.
July 18, 2007
"Last Thursday, U.S. stocks had one of their best days in years, with the Dow Jones industrial average and the Standard & Poor 500 stock index both jumping about 2 percent....
The Wall Street Journal led its Friday paper with this headline: "Dow Again Soars to Record High Despite Unease." On Tuesday, the Dow cracked 14,000 for the first time, before closing at 13,971.
Technically, all the talk about records is perfectly accurate. But it is also fundamentally wrong. In fact, the attention that is being showered on "Dow 14,000" goes a long way toward explaining why the U.S. economy has become so susceptible to speculative bubbles.
The idea that stock prices tend to rise over time really should not be surprising. The price of almost everything rises over time, thanks to inflation. Each year, governments print more money, which is the main reason that the price of groceries, cars, clothes and, yes, stocks keeps on going up. Of course, incomes are rising, too.
This doesn't mean, however, that ...everyone is always getting richer... And the stock market's record high does not mean that stocks have been a wonderful investment lately. They haven't been.
The S&P 500, which is a much better measure than the Dow, closed Tuesday at 1,549.37, just 1.4 percent higher than the peak it reached in March 2000. Think about what that means. While the price of nearly everything has risen in the United States over the least seven years - the price of bread has increased nearly one-third, for instance - stocks have barely budged. They have only marginally outperformed cash sitting in a bureau drawer. So if we are going to talk about a stock market record, we should be doing the same for a whole lot of other things: "Loaves of Bread Surge to New Highs!"
I realize that this point can sound like statistical nitpicking, but it actually relates to something quite important. When you overlook inflation, you can start to think that every investment is a can't-miss investment, because its value always seems to be going up.
This mistake, combined with the enormous attention that society now devotes to the value of its investments, helps create the conditions for a bubble.
A few years ago, I was interviewing a real estate agent in the U.S. Midwest, and she mentioned that her daughter had recently sold her house for 30 percent more than she had bought it for a decade earlier.
"Where else can you get a return like that?" the agent asked. One answer, which I didn't give, is a boring old savings account.
The only meaningful way to measure an investment is to strip away the distortions caused by inflation. You're then able to focus on its real value - what it can buy in the marketplace - rather than just a number on a piece of paper. (A good rule of thumb is that something appearing to have doubled in price or value since the early 1980s costs the same now, in real terms, as it did then.) When you make these adjustments, it becomes disturbingly obvious that stocks and real estate are by no means can't-miss investments.
The average house in the New York region sold for roughly the same nominal price in 1997 as it had in 1988, which in inflation-adjusted terms means its value dropped 31 percent. House prices in New York didn't exceed their 1988 real value until 2002. Then they soared like never before.
The New York stock market has suffered through even longer stretches of mediocrity. The S&P 500 first went over 100 in the summer of 1968. In 2007 dollars, that means it was up near 600. It then entered a long period in which it failed to keep pace with inflation - leading to BusinessWeek's famous 1979 magazine cover article, "The Death of Equities" - and didn't exceed its real 1968 high until 1992. Over the next eight years, it tripled, even after taking inflation into account.
Today, the S&P remains 17 percent below its inflation-adjusted 2000 peak. A share in a mutual fund tied to the S&P 500, in other words, can't buy nearly as much today as it could in early 2000. Now, in a way, this might be considered a good sign. If the market isn't really at a record high, it may still have a lot of running room. But I wouldn't be too confident about that. Relative to corporate earnings, stocks remain more expensive than they have been at any time except the 1920s and the 1990s.
That's the thing about bubbles: They usually take a long time to overcome. The normal pattern after a huge boom - like the sort we recently had in stocks and then real estate - is years if not decades in which an investment doesn't keep up with savings accounts. And what kind of a record is that?"
The illusion of investment profits.
Below are excerpts from the article.
July 18, 2007
"Last Thursday, U.S. stocks had one of their best days in years, with the Dow Jones industrial average and the Standard & Poor 500 stock index both jumping about 2 percent....
The Wall Street Journal led its Friday paper with this headline: "Dow Again Soars to Record High Despite Unease." On Tuesday, the Dow cracked 14,000 for the first time, before closing at 13,971.
Technically, all the talk about records is perfectly accurate. But it is also fundamentally wrong. In fact, the attention that is being showered on "Dow 14,000" goes a long way toward explaining why the U.S. economy has become so susceptible to speculative bubbles.
The idea that stock prices tend to rise over time really should not be surprising. The price of almost everything rises over time, thanks to inflation. Each year, governments print more money, which is the main reason that the price of groceries, cars, clothes and, yes, stocks keeps on going up. Of course, incomes are rising, too.
This doesn't mean, however, that ...everyone is always getting richer... And the stock market's record high does not mean that stocks have been a wonderful investment lately. They haven't been.
The S&P 500, which is a much better measure than the Dow, closed Tuesday at 1,549.37, just 1.4 percent higher than the peak it reached in March 2000. Think about what that means. While the price of nearly everything has risen in the United States over the least seven years - the price of bread has increased nearly one-third, for instance - stocks have barely budged. They have only marginally outperformed cash sitting in a bureau drawer. So if we are going to talk about a stock market record, we should be doing the same for a whole lot of other things: "Loaves of Bread Surge to New Highs!"
I realize that this point can sound like statistical nitpicking, but it actually relates to something quite important. When you overlook inflation, you can start to think that every investment is a can't-miss investment, because its value always seems to be going up.
This mistake, combined with the enormous attention that society now devotes to the value of its investments, helps create the conditions for a bubble.
A few years ago, I was interviewing a real estate agent in the U.S. Midwest, and she mentioned that her daughter had recently sold her house for 30 percent more than she had bought it for a decade earlier.
"Where else can you get a return like that?" the agent asked. One answer, which I didn't give, is a boring old savings account.
The only meaningful way to measure an investment is to strip away the distortions caused by inflation. You're then able to focus on its real value - what it can buy in the marketplace - rather than just a number on a piece of paper. (A good rule of thumb is that something appearing to have doubled in price or value since the early 1980s costs the same now, in real terms, as it did then.) When you make these adjustments, it becomes disturbingly obvious that stocks and real estate are by no means can't-miss investments.
The average house in the New York region sold for roughly the same nominal price in 1997 as it had in 1988, which in inflation-adjusted terms means its value dropped 31 percent. House prices in New York didn't exceed their 1988 real value until 2002. Then they soared like never before.
The New York stock market has suffered through even longer stretches of mediocrity. The S&P 500 first went over 100 in the summer of 1968. In 2007 dollars, that means it was up near 600. It then entered a long period in which it failed to keep pace with inflation - leading to BusinessWeek's famous 1979 magazine cover article, "The Death of Equities" - and didn't exceed its real 1968 high until 1992. Over the next eight years, it tripled, even after taking inflation into account.
Today, the S&P remains 17 percent below its inflation-adjusted 2000 peak. A share in a mutual fund tied to the S&P 500, in other words, can't buy nearly as much today as it could in early 2000. Now, in a way, this might be considered a good sign. If the market isn't really at a record high, it may still have a lot of running room. But I wouldn't be too confident about that. Relative to corporate earnings, stocks remain more expensive than they have been at any time except the 1920s and the 1990s.
That's the thing about bubbles: They usually take a long time to overcome. The normal pattern after a huge boom - like the sort we recently had in stocks and then real estate - is years if not decades in which an investment doesn't keep up with savings accounts. And what kind of a record is that?"