Re: Financial topics
Posted: Tue Aug 03, 2010 1:30 am
Then you have to explain away Japan, China, Sweden and Germany, all of which have more government interference in their economies than does the US.
I am going to dispute this for the very reason that stocks are financial assets and not nominal money ones. If you go to Robert Shillers data, which he used to write the book "Irrational Exhuberance", you will find that inflation between 1895 and 1920 was as bad as it was between 1975 and 2000. He posts not only the monthly prices in the equivalent to the SPX, but also the CPI figures as well. [url]http://www.econ.yale.edu/~shiller/data.htm I spent well over 100 hours working on this data.
There is more to this as inflation is brought about by credit. The difference between the gold standard and the current standard is that at some point people would get nervous about the solvency of banks and bank notes and line up to get the gold out of the banks. Until then, they could inflate as much as they dared. The value of money is in the payment of debt and inflation occurs when debts are easy to pay, which is totally contrary to what people think. People are led to believe that it is the reverse, that inflation makes debts easier to pay, but in reality, inflation is the continued increase in credit, which keeps a steady supply of money in circulation. Once credit has reached its limit, which is where we are today, you can't inflate it any more and debts become harder to pay and the term "This note is Legal Tender for all Debts Public and Private" begins to mean something.
There are 2 sets of liabilities in a credit system, the lenders and the borrowers. The lender creates credit in return for liens or notes, depsnding on whether the debt is secured or not. In doing so, they create a liability of theirs to circulate as money. A credit crunch develops when the capacity of major financial players to pay their debts is in question, ala Citicorp, Bank of America, Lehman Brothers, Royal bank of Scotland, Credit Suisse, Bear Stearns, General Electric credit, etc. In the meantime, these outfits sustain their lending monopoly by a series of short term and long term loans between themselves, one portion of the system carrying the excess lending in some form of the other portion. Once the creation of credit ceases, no more excess money is created and liabilities of banks and their customers become harder to service. We have reached that point.
The notion that the Fed has fixed this is far from correct. What the Fed did was create funds out of assets the banks found unmarketable in order that they can service the debts between themselves. The game going into this mess was to create make believe money in the form of swaps and repurchase agreements and other derivatives that allowed all players to pretend they could come up with the money to service tehir liabilities. It only took the weakest link breaking for this game to end.
What values stock is dividends as they can be discounted in the future. I attempted to condense what I had developed out of Shillers data in 2003 in this post on my blog. http://mannfm11.blogspot.com/ Where the whole inflation idea falls apart is high inflation requires higher discount rates in order to normalize cash flows and discount value. Thus, with 2% inflation, one could use an 8% discount rate for the SPX. Using averages, dividends grow a little less than 1% over inflation, depending on the health of the inflation. So, if we have dividends of $22 on the SPX, which is close, the formula for valuing the SPX would be P=D/K-g, with k being 8% and g being 3% or inflation plus 1. The proper value in this light would be 22/(.08-.03) or $22/.05 or $440.
This formula prices the market to return 8%. If you price the current market based on the 2% dividend, then you have figure that you are paying roughly 250% of real value and to get to real value after inflation, the factor would utilize a 3% growth rate on one had on the $440 price and a 2% growth rate on the other. Thus in 72 years, inflation quadruples price, meaning the target at buying at 1100 on the SPX in real value against what the index is really worth is still short. 440 will double 3 times at 3%, meaning the market would be fairly valued at 3360 in 72 years. In theory, if the dividend increases 3% every year, then buying at 1100 would yield you 2% plus 3% or 5%, not 8%. In order to make 8% on the SPX, it has to be priced to yield 8%. So, at the current 2% dividend and 2% inflation and 1% real growth, the SPX would pay a 2% dividend next year at SPX 1133, based on a current 1100 price.
So, real return is dividend plus roughly 1%. What isn't counted in this is the losses that could come about. When credit growth stops and even reverses as it is doing now, earnings erode. So, we might be looking at P=D/k-g, where g might be -5% for the next 20 years. So, if inflation is -2% and growth is -5%, k is going to be 4% and k-g is going to be 9%. In this case, the $22 dividend is worth about 242.
One must remember that all there is out of stocks is the flow of dividends plus the liquidation value of the stock. Sure companies are acquired, but usually they are acquired by an estimate of the income they can pay to their acquirer, which is the dividend. In order to grow, a company must reinvest its surplus, so the option is not to fail to spend the surplus in excess of dividends. Companies that are buying back their stock are liquidating. You might take a look at a company like CSCO for example, which has spent a fortune on buying back stock over the past 10 years and is now worth about 25% of its peak value in 2000. A growth company that has continually bought back its own stock and paid nothing in dividends has resulted in almost no real gain to their shareholders for the past 11 years.
I use this formula because it was what I learned in the school of finance where I received a degree in the 1970's. Plus, there is no other formula to value a financial asset than discount. There is also, over the long haul, not much of a way to beat risk free assets in return. The theory can do it, but it only goes on as long as there is inflation. If you check inflation figures and take out for capital gain taxes, you will find that the Dow holder in 1966 didn't get even until the mid 1990's. All he drew was dividends, which were substantial and if a company paid none, the holder of the stock made nothing after inflation for that long. If the company went broke in the intervening 30 years, the shareholder was left with nothing. How do you think the shareholders of Citi feel now with stock at $4 and their ownership diluted?
Lastly, John pointed a finger at boomers and X-ers. The market in 1966 was as richly valued as it was in 1929. The oldest boomer was 20 in 1966. Why did they do it again?