Monday, February 23, 2009

Thoughts on the bottom

I don't think we're at the bottom, but I think we can probably see it from here. Three data points, and some thoughts on this.

One, stocks are still expensive by historical standards. Maybe after today's selloff they'll be more in the ballpark, but despite all the hysteria we're still above historical P/Es:

"By this measure, the P-E ratio of the S.&P. 500 is now about 14.5. It’s below average [which is 16], but not enormously so. By comparison, this ratio fell to 6 during the 1930s and 7 during the early 1980s. In short, stocks are a little less expensive than their historical average. But they are far more expensive than they were at the worst points of the other two worst recessions of the past century."

Two, housing prices are way down, but somewhat incredibly, sales are brisk:

"An estimated 29,458 new and resale houses and condos were sold in the state last month, an increase of 53.9 percent from the year-ago period, DataQuick said."

Three, the stimulus is going to work very well, and the bank & housing plans are going to work well enough. Richard Norton's The American Dream vs. The Gospel of Wealth has a collection of very clear charts illustrating the benefits of demand side tax cuts. It is not the whole story since it mostly leaves out the advantages of investing in society, but it's a good start. Unfortunately none of the charts appear to be available online, although this page seems to have at least some of the data he collected. But basically, business investment goes up, unemployment goes down, real income & GDP growth goes up, and so on and so forth.

US stocks & housing were both overvalued because for decades, there was so much loose money in the top of the economy that it had nowhere to go but chase sketchy deals. But this week is budget week. Obama is going to propose - and pass, with or without Republican support - a modest tax increase on the wealthy. We are finally shaking off supply-side and taking money that was chasing its tail in the bubbles and investing it, in the old sense of investing (i.e. putting money to work). The next phase will be a wringing out of excesses, Volcker-style, which will involve pain but is the only path towards putting the economy back on a long-term path to growth.

Stocks coming back into line with historical averages is going to be part of that process. If anything they should be well below historic P/E averages, because there are still a lot of things that could go horribly wrong. Obama and the Democratic leadership successfully navigated the stimulus past the neo-Hooverites and the Santellis, but now for it to be effective we have to get it past the kleptomaniacs. It's not at all clear that our democracy is up to the task. And the Santelli types are disorganized and inchoate at the moment, with little to lose they have an opportunity to take bigger strategic risks. They're going to pitch a thousand hissyfits over the budget.

The irony here is that on some level (and apologies for this, Senator McCain), the fundamentals are strong. The question is how dig do you have to deep to find them (and the other question is how tone-deaf of a politician do you have to be to say that at the beginning of a mini-depression). A $50+ trillion "market" collapsed over the past few months. That's a lot of horseshit, but at the center of it, there is still a $15T pony under there. That pony is the greatest consumer market the world has ever known. This is why sales of California housing is brisk. Even with wave after wave of foreclosures, there are either enough people who saw this coming and waited patiently on the sidelines to drive demand, or the speculators are getting back in. Hopefully it's the former.

Yes, there will be rubble from the collapse. The best technical bookstore in San Francisco, Stacey's, is right across the street from my office. It's closing and this is a terrible loss. We may skip along the bottom for a while. But while we will get through it in some fashion, the big outstanding question is whether we can use the crisis to put our economy (and our lives) on a more sustainable course.

1 comment:

Dan said...

Good summary, I agree with it generally. One comment about the stock market:

In 1981 the 10 year T-bill hit 15% - you'd need a p/e below 7 to equal that yield. Right now the 10 year T-bill yields under 3%, so equities investors are willing to own a higher p/e. A few months back I tried to calculate the historical market level based on the ratio of market cap to GDP, which is a metric favored by Warren Buffet. I came up with a DOW between 5000-7000. We're approaching that range now.