Is Bull Market Exhausted?
We live in very prosperous times. The economy has been expanding at a very steady rate over the past eight years. More people are employed than ever before: 138 million. The unemployment rate is at a 29-year low of only 4.5%. Inflation is under 2%. As a consequence, standards of living are improving for most people, and the times, they are good.
Academics often use the “misery index” to measure the state of the economy and the well-being of a society. This index, the addition of the unemployment and inflation rate, currently measures a very low 6.5%. In the early 1980s, we suffered triple the misery level of today as the index hit 24% with inflation at 14% and unemployment at double-digit levels.
So, we should conclude that there is nothing to worry about, right? Wrong. The chief worrier in the U.S. is Federal Reserve Board Chairman Alan Greenspan. In recent testimony before Congress, he again told of his worry about the stock market level and the “wealth effect” that it might be creating.
Simply put, Greenspan is worried that the increased value of stocks held by families will cause consumers to spend more with the result that prices will increase, labor costs will go up and inflation will return.
Over the past four years (1995 through 1998), common stocks have appreciated each year by more than 20%. In terms of the dollar value of all publicly traded stocks, total market capitalization has more than doubled in the past four years, from $4.5 trillion at the end of 1994 to $11.3 trillion the end of last year.
These figures are mind-boggling. Since our annual gross domestic product totals $8.5 trillion, the value of all traded stocks now represents 133% of the GDP. To put that number in perspective, the value of stocks in relation to GDP is usually about 60% and has exceeded 100% only once before. The only previous exception was right before the 1929 market crash.
Another way to measure the wealth effect is to divide the increase in market value of all traded stocks over the past four years, $6.8 trillion, by our population, 270 million. This results in $25,000 for every man, woman and child in our country. Of course, equity wealth is not that evenly divided, but you get the idea. Assuming equal distribution and a family of three, equity values have added $75,000 to the wealth of each family in just four years.
These figures are reflected in the very high rate of consumer spending, which is the largest item in the economy. The wealth effect has contributed to an almost zero savings rate--the lowest for any industrialized country. This is partly because the retired generation is spending down their savings, which offsets the retirement savings of the generation that followed them.
The wealth effect is also evident in the current record level of consumer debt of $1.3 trillion. Except for a third of that, which is financing car purchases, most of the rest is credit card revolving debt. Because many are exceeding their credit capacity, we are experiencing a record level of personal bankruptcies.
By all common measures of stock market value, the current market is very highly priced. Those measures are the stocks’ very high price-earning ratio, very low dividend yield and very high price-to-book ratio.
What is the stock market telling us? It likes baby boomers putting money away for their retirement. It likes low interest and low inflation rates. It likes the decrease in federal government deficits. It likes low unemployment. It likes the high confidence level of Americans. It likes the technological and productivity increases. It likes the fact that we won the Cold War and other countries are emulating our economic and political system and are investing in our economy. And lastly, it likes the prospect that some future Social Security retirement moneys might be invested in the stock market.
The U.S. makes up the largest share of the world economy. In terms of product and equity, we are over a quarter of the world’s total. If Greenspan did not have to also worry about the effect of our interest rates on the world economy (with problems in Southeast Asia, Brazil and Russia), the Federal Reserve Bank might have already increased domestic interest rates as the U.S. economy expanded at the relatively torrid rate of 6% in the last quarter of 1998.
When (not if) the Federal Reserve Board increases interest rates, this will bring the stock market party to an end as higher interest will cause both stocks and bonds to fall in value. Then, we will feel less wealthy and we will spend less. This will contribute to the economic downturn and prove, once again, that the business cycle is alive and well. Let us hope that our next recession and bear market does not last as long as it has in Japan: almost a whole decade.
