Let's see if it also works on stock market bubbles.
Let's start with a theory that there is a constant ratio between the market value of corporate equities and mutual funds to the replacement-cost value of durable goods. No matter what the government tries to do, this ratio cannot be altered. It can be temporarily distorted but it cannot be permanently changed.
The linear trend line actually partially supports this theory. If not for the two most recent bubbles I think that trend line actually would be flat. Therefore, let's use the average value of the ratio in the chart above to generate a new trend line in the following chart below.
The trend line is simply the replacement-cost value of durable goods times a fixed average ratio of 1.94.
First came the dot-com bubble. It was followed by an equally impressive echo bubble. Investors sure are a glutton for punishment. As of Q4 of 2009, assuming this theory has any merit at all, then stocks are once again expensive. Can they get even more expensive? Sure. Would I buy them at these levels? Not really.
Behold the power of durable goods. Too bad we outsourced them.
Here's some more bad news.
The red trend line is an exponential growth curve. We're no longer on it. If the replacement-cost value of durable goods is no longer following the exponential growth curve, then neither stocks nor housing are probably following it either. Is it any wonder that Ben Bernanke feels the need to fight deflation? Is higher priced oil really going to solve our problems though?
These are just my opinions. This is not investment advice.
See Also:
A Grand Unified Theory of Real Estate Malinvestment
Trend Line Disclaimer
Source Data:
FRB: Flow of Funds
Fantastic posts Stag!
ReplyDeleteThanks!
remy,
ReplyDeleteI'm starting to wonder if we crossed the economic Rubicon in the mid 1990s and nobody bothered to tell us.
These stock charts seem to point to 1995 as the starting point of the first stock bubble.
The housing charts in my previous post seem to point to 1997 as the starting point of the housing bubble.
Here's the amusing part to me.
I sold stocks in 1997 to make the 20% down payment on the house I am currently living in. I only owned those stocks for a few years and they treated me extremely well.
There were plenty of people buying houses then. There was an actual bidding war on my neighbor's house not long after I moved in.
Without the gains from the stock market, I would have bought a smaller home. If I had bought a smaller home, I would not have helped fuel the housing bubble. Go figure.
Very Nice work. Thank you. An article recently revealed that the steel industry and iron ore industry have totally revamped universal standards for market pricing. The bottom line, anything made with steel will cost more which will increase the price of durable goods with a few exceptions.
ReplyDeleteI apologize for not being able to source this, I read a lot and sometimes fail to save the link and too lazy to sift through my history.
Bottom line, the argument about inflation/stagflation/deflation is yes. Inflation in common items of need, stagflation otherwise or deflation in consumer discretionary, the more frivolous, the greater the decline.
One caveat of course is the price of energy/oil. The current manipulation in energy and PMs will crush any nascent recovery on Main Street. The close on Thursday was knocking on the door of $85/ppb despite historic demand destruction in the US and overflowing supplies. Speculation is for this to continue throughout the summer. If this is an muted '08 redux in runaway inflation due to massive manipulation, the big boys will make their bonus goals in less than a quarter while government and Main Street suffer more than 2 years ago as the economy is fragile.
Sociopaths can't help themselves I suppose.
Such is our Brave New World.
NS
If the "replacement-cost value of durable goods" is proportional to the replacement-cost value of the capital goods that firms own, then haven't you discovered evidence in support of Tobin's "Q" as a measure of share valuation?
ReplyDeleteAnonymous,
ReplyDeleteOne caveat of course is the price of energy/oil. The current manipulation in energy and PMs will crush any nascent recovery on Main Street. The close on Thursday was knocking on the door of $85/ppb despite historic demand destruction in the US and overflowing supplies. Speculation is for this to continue throughout the summer. If this is an muted '08 redux in runaway inflation due to massive manipulation, the big boys will make their bonus goals in less than a quarter while government and Main Street suffer more than 2 years ago as the economy is fragile.
You might find this interesting. In 2008, TIP (inflation protected treasury fund) started to sell off about 3 months before oil peaked. It's like TIP saw the pain coming. I rode it out in TIP, but certainly felt the deflationary pain.
In November of 2009 I sold a good chunk of TIP. Since then cash has outperformed it.
It might just be a coincidence. In any event, I do think there is a risk of a mini 2008 redux and for exactly the reason you describe. I doubt it will be that easy to time though. I don't think oil will make it to $145 again. I would bet that there are already at least a few itchy trigger fingers hovering over the sell button, especially with natural gas struggling.
Speaking of natural gas, check out this messed up fund.
United States Natural Gas (UNG)
It has performed so much worse than natural gas over the period and has been an utterly awful inflation hedge.
Behold the power of "zero-sum" derivatives.
dearieme,
ReplyDeleteI had not heard of Tobin's q. Thank you so much for posting that! This is what I love about blogging.
Tobin's q
Tobin's q was developed by James Tobin (Tobin 1969) as the ratio between the market value and replacement value of the same physical asset:
One, the numerator, is the market valuation: the going price in the market for exchanging existing assets. The other, the denominator, is the replacement or reproduction cost: the price in the market for the newly produced commodities. We believe that this ratio has considerable macroeconomic significance and usefulness, as the nexus between financial markets and markets for goods and services.
I'm certainly in the same ballpark with the charts I have done. I was coming at this from the data in the "Balance Sheet of Households and Nonprofit Organizations". In other words, I was focusing on the consumer end.
Very interesting.