Arnold Kling  

No Bubbles Here. Move Along Now

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WSJ Real Time Economics reports on a speech by the Fed's Don Kohn,

Our abilities to discern the 'correct' values of assets is quite limited. At present, however, the prices of assets in U.S. financial markets do not appear to be clearly out of line with the outlook for the economy and business prospects as well as the level of risk-free interest rates. Most bond spreads and equity premiums are still appreciably higher than a few years ago and comparable to their levels in past recessions. Moreover, money and credit have been quite weak, suggesting that asset price movements have not been fueled by increased leverage that would leave financial intermediaries vulnerable to a reversal of recent gains.

So, there you have it. No bubble. I personally am a bit more bubble-shy than Mr. Kohn, and I have reduced the "beta" of my portfolio quite a bit since the summer, thereby missing out on much of the recent rally. I am not sure what stock market investors are thinking. I can understand why the combination of 9.5 % annualized productivity growth and interest rates close to zero would be good for stocks, but I would be surprised if we see that continue.

I get the sense that Kohn and Bernanke think that financial markets eventually will get back to "normal," where that is defined as what existed in 2007. In their view, 2008 was a freak liquidity crisis. Those of us who are more Austrian in leaning tend to think that the necessary reallocation of physical and human capital might result in an economy that does not bear quite so much resemblance to the economy of 2007.

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CATEGORIES: Macroeconomics

COMMENTS (2 to date)
Ironman writes:

Stock prices are very much running to the hot end of the spectrum, but are still within the range they should be given the value of their underlying dividends per share and the changes in the growth rate of that measure that investors see going forward.

There is one concern which will become increasing relevant beginning on 17 November - the drying up of a source of funds that has been in part fueling the hotter than expected performance of the stock market since September 2009.

Speaking of normal where the stock market is concerned, that requires that trailing year dividends per share be expected to grow consistently over a sustained period of time. The earliest that could begin to happen will be March 2010. It's not going back to the old "normal" - the new normal will have a new base with a different trajectory.

Matthew C. writes:

It's a liquidity-fueled bubble. And yes, it is going to end terribly badly in the near future as the real economy (measured by things like unemployment, tax receipts, freight loadings and post-Christmas retailer bankruptcies) overcomes the lemming race for performance.

Ironman, I hope you have quick reflexes to dump your high beta portfolio when it becomes clear to everyone that we are in another depression, driven by toxic levels of debt that must be written off, not "pretend and extend"-ed.

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