BUt be fair! Add back in the stock repurchases in lieu of dividends!

So, instead of falling by 60/22, all you need is about 60/40. Stocks are only one-third too high to achieve 6.5% long term returns!

Now, the only problem. Who will buy all the shares being sold off to cover stock options. Hmm.

Brad,

Steve Roach and some of the other bears have been predicting this for nearly a year. Those P/Es can't be maintained when the fundamentals are so weak.

I do add them in! The stock buybacks are in there!

and of course, the flow of funds into the market under the personal accounts would make the price-dividend ratio even worse (if the CEA crash doesn't happen).

test

Brad, you left out the most likely possibility: that every year the companies return 340% of profits as dividends. Duh.

Ahh a stock market crash is just a little added benefit to those in the ages 48-54! Not only will your benefits get cut but you'll have a crashed market to deal with!

We are assuming the p/e ratio stays a constant. Growth is assumed to be 1.9%. Then growth in earnings can be 0.9% and stock buybacks can be 1.0% which gives 1.9% stock returns. Add in dividends which are 1.6% for the S&P after Vanguard costs. That gives us 3.5% stock returns.

But, the Council of Economic Advisors assumes real stock returns can be 6.5%. There is a gulf between 3.5% and 6.5% that can only be made up if stocks fall in price raising the dividend or if the p/e actually rises to remarkable levels.

Brad,

How about a link for the CEA story?

[Can't find one as of yet...]

Oh. Wow!

Look out below!

Working from John Bogel's stcok returns model, I added starting S&P dividends of 1.6% to Brad's numbers.

With an expected economic growth of 1.9%, we can expect nominal stock returns to be 3.5% real and 3.0% inflation for 6.5%. I assumed the p/e ratio constant at about 20. A nominal return on stocks of 6.5% is what we can expect from the COE growth estimate. But, the COE suggests the nominal return will be 9.5%.

"and the earnings growth on a stock index averages one annual percentage point less than real GDP growth"

The data for real earnings of the S&P 500 from 1929 to 2004 on Robert Schiller's website seem to show that on an annualized basis

real earnings growth = real gdp growth - 2%

I.e., earnings growth is 2% less per year than GDP
growth, not 1% less.

Also, Robert Arnott has shown (Earnings Growth: The Two Percent Dilution) that in the 20th century the net result of share repurchases and new share issuance from stock options etc was a 2% dilution per year.

(I'm not entirely sure whether Shiller's data for the S&P earnings does not already incorporate the share dilution).

"Working from John Bogle's stock returns model, I added starting S&P dividends of 1.6% to Brad's numbers."

Am I right or wrong in taking the Bogle model and adding the starting dividend to Brad's calculations? Brad gets a nominal return of 4.9%, while I get 6.5% adding dividends. Both numbers are far short of the CEA figures.

Forgive spelling errors above; the day was so long.

I'll be happy to co-author the book about this Brad --- we can call it "Dow 3,600."

I don't know what the hell you wonks are talking about, but it sounds BAD. Should I sell Pepsico and Proctor and Gamble? How about GM bonds earning 5% for four more years? And where do I put the cash, under the mattress?

I would guess that companies would be less willing to buy back their own stock if stock became too expensive from of the flow of social security funds into the market. The debt that the US would have to undertake in order to privatize SS would almost certainly increase interest rates (more debt = greater risk ----> buyers of US paper demand higher rate of return). Higher cost of capital ---> less incentive to float bonds in order to obtain capital -----> (perhaps) lower free cash flow to buy back stock. Slippery slope argument, perhaps, but maybe worth considering.

Any prediction about collapse of 10 year bonds if US borrows trillions in order to make the adjustment to privatized SS? If I were a long term investor, I would consider shorting them. Owning US paper is usually referred to as risk-free return. I think a better description might be "return-free risk."

Should I sell my house?

Should I sell my house?

The guys at BOPNews have been working on this for months. It is all intentional, all part of a plan.
Brad can't explain the risk premium, or why China continues to buy treasury bills that are losers. He thinks the budget deficits are accidents of incompetence. I am no economist, but these guys(DeLay, Rove, Greenspan) are trying to engineer a great depression in order to overturn the New Deal and completely restructure American society. They intend to elimibate the middle class.

As Krugman implied years ago, they are profoundly, revolutionary, radically evil.

We are looking at Peter Pan economics.

If you believe hard enough, and clap loud enough, you can not only keep Tinkerbell alive, you can IN fact "...make up this 6.5% per year real return".

Works in childrens' panto -- works on Wall Street.

They're certainly trying to take the US back to the 1890's. The good old days, when the federal government did nothing to help states hit by natural disasters, shooting labor union organizers was legal, and child labor laws were unconstitutional. (Fundamental right to contract.) Federal wage and hour laws? Struck down by the Supreme Court as violating states' rights.

I've always suspected the New Deal and other workers' rights came about because the powers that were worried about a populist revolution headed by either communists or Huey Long. Now that the threat of revolution by oppressed workers seems remote, the bad old days seem like a good idea to folks that equate meritocracy with choosing rich parents.

Bush's plan is to remake the US as a Third World country - he and his friends play the aristocracy, we get to be the urban poor living in shantytowns.

All you have to do is assume that p/e ratios can grow without limit and you've solved the problem. Why can't we have p/e inflation add 3%-4% per annum in stock returns? Don't you belive in freedom?

Me: Hello?

MGS: Yes...This is Money Going South, Inc. , the Private Accounts Division of the former Social Security Administration. How may I help you?

Me: I retrieved my account on line and three fourths of my money is missing. What happened?

MGS: Let me take a look. Account number please.

Me: xxx-xx-xxxx

MGS: Yes, it does look like your account is in a declining balance. How may I help you? Do you wish to change options?

Me: Do you mean move it to a more risky option? I'm losing money and I'm in the lowest risk option. What happened???

MGS: It appears that you have initiated retirement drawdown on your account. Only you have the password.

Me: Lady, I'm only 37.

MGS: How may I help you?

Me: Fix my account! Restore the money that is being ripped off.

MGS: Sir, you'll have to fill out MGS-FirstGov Form 2006-YouAreScrewed and submit your request to the commission for consideration. Five copies please.

Me: How long will that take?

MGS: Presently, we're experiencing some difficulty processing claims. Perhaps two years. How may I help you?

Me: Oh, hell. How do I close my account? I tried that online last week and the request was rejected.

MGS: Yes, sir. That would happen. Paragraph 207-14b(1)(f) in your original contract explains that you can not opt out until you're vested. Looking at your account, you still have four years to go. Sorry, sir. How may I help you?

Me: Who else can I talk to?

MGS: The senior supervisor, but she is in India training our data processors and account managers.

Me: Where are you?

MGS: I'm sorry, sir. I'm not allowed to disclose that.

Me: Can you give me a clue?

MGS: Your country liberated mine right after you set up Iraq. Remember?

Me: Oh, hell. You're in North Korea.

MGS: Yes. How may I help you?

Me: I think I'll call back later.

MGS: Sir, I don't recommend that option. As stated on the back of your MSG Private Account card, personal telephone communications are limited to two times a year. How many I help you?

Me: Grrrrr... Ok, what other options do I have?

MGS: We do offer a margin recovery investment program which will allow you an opportunity to recapture some of your recent drawdowns. Would you like that option?

Me: Don't know. What do I have to do?

MGS: Just say YES! I will process it.

Me: Hmmm. Ok.

MGS: Thank you, sir. Let me give you your confirmation number. One moment please.

Me: Ok.

MGS: I'm sorry, sir. The request was denied. The account is already margined. How may I help you?

Me: What!! @#)*)(*$#^!! @#&#@&^#!

MGS: I'm sorry, sir. How may I help you?

Me: I have to go...

MGS: Have a nice day, sir. And thank you for investing with MSG.

...perhaps the administration is covertly trying to prepare us for the rapture...

Yes, but...Even if the Bush administration doesn't know (and perhaps Bush himself doesn't know, but surely someone does) what makes anyone think they care?

By the time the crash comes, Bush will likely be out of office, and the beginning of the end of social security already a done deal.

Here's something else: ask yourself who really gets screwed.

There are between 77 and 100 million boomers, about half of whom are invested in equities. If privatization comes to pass, they will have at least most of the 40-60 some million generation xers, and perhaps another 10-20 million adult age generation yers, as near guaranteed buyers of those stocks, and likely at wildly inflated valuations.

Unless the crash comes soon, and I tend to think we will probably slog along until the early part of the next decade if not past that, the younger generations, especially those born in the 1960s and 1970s, will have been conned by their own government into buying severely overvalued stocks only to watch those stocks crash within a few years, while still having to pay for the retirement of the boomer generation. Our elders will make out like bandits, and our retirement security will be decimated.

If Alan Greenspan and the Treasury Department will stand aside long enough to get the ball rolling down hill. To this point, however, evidence is fairly plain that the two agents have been diligent in their attempts at keeping share prices afloat and rates lower than would otherwise be the case.

In my opinion, it is not a coincidence that the Treasury Department, as a part of the Administration, should cycle $36 billion in short-term loans (repo) into the banking system just as stock market performance is faltering badly, the dollar exchange rate is falling anew, and just ahead of the Iraqi elections and the President's State of the Union Address. I also do not much care for the fact that Treasury is permitted an opportunity to influence monetary policy in this manner.

Thank you, too, Professor Delong, for the insights you've offered that were subsequently broadcast on the social security topic.

This is all very fuzzy math.

A 60% decline in the stock market sounds about right. That would take it to a dividend yield normal for the end of a bear market.

According to the data at http://www.barra.com/Research/fundamental_download.csv
S&P 500 Price/Earnings, Dividend Yield, and Price/Sales as of 12/31/2004 were 20.7, 1.9%, and 1.58, respectively. On 12/31/1981, at the end of the last bear market*, the corresponding figures were 8.1, 6.1%, and 0.41. Since earning seem currently to be greatly overstated through accounting ploys such as overvaluation of pension funds, an S&P 500 value of about 350 at the end of this bear market seems quite possible.

When it gets there, I'll start buying.

http://www.ess.ucla.edu/faculty/sornette/prediction/index.asp

The problem with Brad's calculations is that he falsely assumes that 2+2=4.

Not Peter Pan economics, Enron economics.

When they say stocks will grow by 6.5% a year, what do they mean, exactly? That the Dow Jones index will grow an average of 6.5% a year? If so, that is perfectly consistent with 1.9% overall growth, as the DJIA is not a closed system - the list of stocks on the DJIA changes regularly, and as you can imagine, it is not overperforming companies that are dropped from the index. For instance, in April 2004, AIG, Pfizer and Verizon replaced AT&T, Eastman Kodak and International Paper. Kodak is clearly heading down the drain, we know what is happening to AT&T.

Like dust swept under the carpet, or Enron's debts laundered through dodgy subsidiaries, this constant churning of the Dow Jones Industrial Average is one factor that gives the illusion of higher returns. Even an index based on the entire market is not exempt from this problem, as poorly performing or bankrupt companies are delisted.

Peter Diamond has written a lot about these issues:
http://econ-www.mit.edu/faculty/?prof_id=pdiamond&type=paper

"What Stock Market Returns to Expect for the Future: An Update" (DRAFT July 9, 2001):
http://econ-www.mit.edu/faculty/download_pdf.php?id=184

"Even an index based on the entire market is not exempt from this problem, as poorly performing or bankrupt companies are delisted."

Is this so? I have been wondering about this exact question for several years, when analysts talk about average returns for the last 10, or 50, or 100 years. Are bankrupt and delisted companies not included in such calculations?

I have often wanted simply to random walk thru the 1925 full listing, buy 100 or 1000 stocks, and see what I had 50 years later. Has this never been done? Instead of using some index value.

Thanks everyone, I'll sleep better tonight, well, not tonight, maybe tomorrow, no... not until I get my new privitized mattress, because, frunkly, as someone mentioned upthread, wherefore am I going to stash my money, because as you money wonks seem to be indicating, and Working from John Bogle's stock returns model, (you don't see a line like that everyday on the nets) we is screwed! Unless we fight back of course.

Wait, it occurs to me an investment opportunity arises!!!!!

Who makes Vaseline?

KY Jelly?

Booze?

I'm visualizing a stock portfolio. Not a defensive one, like buying the "Generals," but an aggressive, who's easing the pain and suffering of the screwed over Americans, those companies dealing in soma and foma and general anaethesia for the huddled masses.

Oh, Serendippity, I kiss you!

The WH is trying to use a rational argument using mathematics to show that investors will receive a certain return in the markets. unfortunately the markets are not rational, they are irrational, subject to the whims of the irrational participants.

I would sugest that people pay their taxes now, take their dollars, and invest them in tangible assets. Pay off your house(s) and car(s). The dollar will not exist in its present form in 20 years. The White House and their masters at the Council on Foreign Relations know this. The average, public school-educated American does not.

These people are already running their simulations on the "new world order" with a "new and improved" dollar. The US will be defaulting on major debt obligations the same way that Russia and Argentina have done in the recent past. There are just too many dollars out there.

Handing over your money to the government in the form of a government savings program is conceding your liberty. Freedom requires responsibility. Freedom entails risk. Get the government out of your life.

Actually if the US administration really is planning to default on all loans through hyperinflation the social security plan suddenly makes perfect sense:
Step 1: Borrow 2 trillion dollars from the chinese and whoever else is foolish enough to buy the paper.
Step two: Park that money in stocks where it is relatively inflation proof, because it represents part-ownership of a buisness rather than a fixed monetary commitment.
Step three: Roll the printing presses until inflation hits 20-300% and watch all debts disappear.
Consequenses? What consequences? The US gets, ehh, what? more unpopular? Less trusted? Bwhaaha-ha-haa
The middle classes get soaked? The minimum wage becomes meaningless ? You actually think the present administration minds this?

http://www.j-bradford-delong.net/movable_type/2005-3_archives/000288.html#comments

Brad DeLong's example does not make a case for a severe bear market or for not investing in stock in our current retirement or taxable accounts. Actually the example gives us reason to be confident about long term stock market returns. The example simply suggests that if long term economic growth is about 1.9% as the Council of Economic Advisors projects, we should not expect nominal stock market returns of 9.5% [6.5% real returns].

We are assuming the p/e ratio stays a constant. Growth is assumed to be 1.9%. Then growth in earnings can be 0.9% and stock buybacks can be 1.0% which gives 1.9% stock returns. Add in current dividends which are 1.6% for the S&P Index after Vanguard costs. That gives us 3.5% real stock returns [6.5% nominal returns].

But, the Council of Economic Advisors assumes real stock returns can be 6.5%. There is a gulf between 3.5% and 6.5% that can only be made up if stocks fall in price raising the dividend or if the current p/e actually rises to remarkable levels or if economic growth is faster than 1.9%.

A 6.5% nominal long term return for the S&P Index would still make for a better return than long term bonds. This is a bullish argument for stocks, just not as bullish as the Council of Economic Advisors argument.

What I did that was different than Brad DeLong is to add the current S&P dividend of 1.6% to the projected return. Should long term economic growth be more than 1.9%, stock market returns can be more than 6.5% with a constant price earning ratio of 20. But, then there is no reason to borrow massively to set aside Social Security for private accounts. Social Security is fine and we may hope the economy grows at least 1.9% over the years so that the stock market will give a reasonable return in our other investments.

bob mcmanus:

Re stock index composition issues. Googling "S&P 500 delisting" and "S&P 500 composition" returns useful references. The investment maangement firm Barra offers much useful information on its website, in particular see:
http://www.barra.com/Research/description.aspx

Clicking "Search" at http://www.barra.com/Research/searchdb.asp without any other entries brings up a full listing of research papers. One that is pertinent is:
http://www.barra.com/research/newsletter/nl166sywtc.aspx

Note that the monthly returns you can download from
http://www.barra.com/Research/DownloadMonthlyReturns.aspx
must be the returns net of the costs of listing and delisting stocks, and of the losses on the delisted losers.

S&P gives full details of S&P 500 composition at
http://www2.standardandpoors.com/servlet/Satellite?pagename=sp/Page/IndicesIndexChangesPg&l=EN&b=4&f=1&s=&ig=&i=&r=1&ft=1&fig=173&fr=0&fs=6

The relevant number for buybacks would be buybacks-new issues or net buybacks ("stock market leakage"=net buybacks + dividends). If massive amounts of funds are redirected in the market, this would most probably turn negative. Also, from what level will new money earn less than old money? Certainly, upward of some level, new investments will not earn the same return.

anne:
It is very unlikely people will get 6.5% returns on investments made at today's high stock prices. Current figures for price/earnings, dividend yield, and price/sales are in the territory that characterizes market tops. It doesn't get any better than this. A corollary is that it is almost certain to get worse.

A 60+% decline in the S&P 500 over the next ten years is quite possible.

Reported earnings nowdays are greatly inflated by factors such as stock options not being expensed, and pension fund accounting tricks. http://newswww.bbc.net.uk/2/hi/business/2838395.stm).

The Financial Economists Roundtable report at
http://www.luc.edu/orgs/finroundtable/CorporatePensions.pdf
highlights the consequences of excessive reliance on stocks with the statement that "In 2003 and 2004, company pension plans were underfunded by nearly $400 billion. In 2000 and 2001 the underfunding was less than $40 billion." It also describes the perfidy of the Pension Funding Equity Act of 2004, by which "Through the magic of government fiat, reported pension liabilities shrink by roughly 20%," and the looming problems of the PBGC.

The smart money is sidling towards the exits.
Corporate insiders last year unloaded $40-50 billion of stock (nearly half the 2004 inflow into equity mutual funds). And it was reported in a post over at Brad Seltser's blog that pension fund managers are moving to reduce their exposure to stocks (now quite high by historical standards), and may move about $650 billion from stocks to bonds.

Consider what the magnitude of pension fund underfunding will grow to as the S&P 500 heads down to 350, and the funds are moved into bonds yielding 4%.

JM

All that needs to be done to make my projection bearish is to assume that a price earning ratio for the S&P of 20 can not be sustained. A return to an historical p/e of 15 is a 25% difference.

Does a p/e of 20 reflect low long term interest rates, less stock market volatility, greater ease of trading, a more flexible and adaptable economy as Alan Greenspan posits?

You are most thoughtful, and I would like to argue about what valuations we might expect, because I am not convinced. I lean to Alan Greenspan's explanation.

Remember, we are passing through a remarkable period. For the last 5 years, the S&P has a -1.9% annual return while the Vanguard Long Term Bond Index has a 10.9% annual return. This is a startling difference.

The 10 year returns are 11.4% for the S&P and 9.7% for the Long Term Bond Index.

Stocks can underperform bonds for a long time, and are doing so now. My sense however is that there is little need for stock market valuations to retun to historical norms, for the economy is more adaptable and the market less volatile. So I am moderately bullish for the long term. A counter to my bullishness however is our problem with fiscal policy.

This looks like the place...

http://www.whitehouse.gov/news/releases/2005/02/20050204-12.html

Meanwhile, keep up the discussion folks, I'm still only paranoid and need to feel truly scared.

Productivity growth has been above 4% these last 3 years, and there is population growth. The potential long term growth of the economy is determined by productivity and population increases. Even if there is a slowing of productivity growth to a level half that of the last 3 years the economy would still be able to grow faster than the 1.9% assumption of the Council of Economic Advisors. Population and potential labor force growth are not stopping just now. We continue to be innovative in technical development and application and work place organization. Then, why not be optimistic about our ability to grow? If we can grow faster than 1.9% the stock market can be more robust than our examples would show, and surely even at 1.9% there is no reason to fear for Social Security.

Brad forgot two important things:

1- The pony we are all going to get, giving us both a major increase in net worth (have you priced ponies lately? I have) and alternate transportation to stave off the oil depletion shock!!

2- Poland.

Brad DeLong is not trying to project stock long term market returns. The argument was with the Council of Economic Advisors trying to do so in defense of forming private Social Security accounts. What makes the model interesting is that if we can guess at economic growth we have a sense of the potential for stock market growth. If economic growth is 1.9% at the CEA projects, we can not reasonably expect more than 6.5% nominal stock market growth.

Anne:

Higher productivity - new technical innovations will help, but they need to come on line very soon. I believe that we're slowing down on productivity gains. And I'm not convinced that all productivity gains necessarily result in GDP growth. Some just hold the line. I believe that this is often overlooked.

I also expect further net productivity gains to be hampered by the growing competition we will experience in world currency reserve holdings' decisions. Unless, of course, national savings improve and fill the gap. Otherwise, we may be facing much higher interest rates.

Who else is concerned? Greenspan, though you wouldn't think so based on his London speech this week. But take a look at his Jackson Hole speech last fall. It's more to the point on the issues we're discussing.

Greenspan, 27 August 2004, Jackson Hole, Wyoming (not the entire speech):

"Although the sustainability of fiscal initiatives is generally evaluated for convenience in financial terms, sustainability rests, at root, on the level of real resources available to an economy. The resources available to fund
the sum of future retirement benefits and the real incomes of the employed will depend, of course, on the growth rate of labor employed plus the growth rate of the productivity of that labor."

"The growth rate of the U.S. working-age population is expected to decline substantially over the next two decades and to remain low thereafter."

"Of course, immigration, if we choose to expand it, could also lessen the decline of labor force growth in the United States."

"But to fully offset the effects of the decline in fertility, immigration would have to be much larger than almost all current projections assume."

"It is thus heightened growth of output per worker that offers the greatest potential for boosting U.S. gross domestic product to a level that would enable future retirees to maintain their expected standard of living without
unduly burdening future workers. Productivity gains in the United States have been exceptional in recent years. But, for a country already on the cutting edge of technology to maintain this pace for a protracted period
into the future would be without modern precedent."

"We obviously cannot attribute recent productivity trends to a high level of national saving. Rather, the effectiveness with which we have invested both domestic saving and funds attracted from abroad is the apparent source of our decade-long rise in productivity growth."

"From an accounting perspective, efficiency gains, broadly defined as multifactor productivity, have accounted for roughly half the growth in labor productivity in recent years. Capital deepening accounts for most of the remainder."

"Should the pace of efficiency gains slow, it would fall to the level of investment to again become the major contributor to productivity gains."

"Investment, however, cannot occur without saving. But maintaining even a lower rate of capital investment growth will likely require an increased rate of domestic saving because it is difficult to imagine that we can continue indefinitely to borrow saving from abroad at a rate equivalent to 5 percent of U.S. gross domestic product."

"A doubling of the over-65 population by 2035 will substantially augment unified budget deficits and, accordingly, reduce federal saving unless actions are taken. For example, aside from suppressing economic growth and the tax base, financing expected future shortfalls in entitlement trust funds solely through increased payroll taxes would likely exacerbate the problem of reductions in labor supply by diminishing the returns to work."

"Changes to the age for receiving full retirement benefits or initiatives to slow the growth of Medicare spending could affect retirement decisions, the size of the labor force, and saving behavior. In choosing among the various
tax and spending options, policymakers will need to pay careful attention to the likely economic effects."

"The decade-long acceleration in productivity and economic growth has seemingly muted the necessity of making such choices. But, as I noted earlier, history discourages the notion that the pace of growth will continue to increase."

"As a nation, we owe it to our retirees to promise only the benefits that can be delivered. If we have promised more than our economy has the ability to deliver to retirees without unduly diminishing real income gains of workers, as I fear we may have, we must recalibrate our public programs so that pending retirees have time to adjust through other channels. If we delay, the adjustments could be abrupt and painful."

http://www.federalreserve.gov/boarddocs/speeches/2004/20040827/default.htm

Movie Guy

Quite an excellent post.

Productivity growth has indeed slowed for 2 quarters, and Stephen Roach who has for a decade doubted that productivity gains were all that real or sustainable is worrying again. Gains in productivity may well be made during times when the economy grows slowly or not at all. This was the case during the Depression. I only argue that productivity gains raise the potential economic growth rate. What I do not find happening now is a slowing of technical advance related to Moore's Law. Information technology is advancing wonderfully as are applications. Will there be serious limits? When? I can not guess. Will there be comparable progress to information technology in the biological fields? I might argue there has been, and will continue to be. I am a technology enthusiast.

Now, Alan Greenspan raises the matter of saving, and there we can worry. There is a government structural deficit, household saving is quite low, only corporate saving is ample and I wish that were turned to more domestic investment.

Population growth. I am thinking, and considering Japan here.

anne:

Re "Does a p/e of 20 reflect ..."

I think the current P/E of 20 reflects negative short-term interest rates, margin debt near end-1999 levels, earnings inflated by corrupt accouting, and investor tolerance of pathetically low dividend yields (due to the near-complete triumph of the greater-fool theory).

Consider this recent article in the IHT
http://www.iht.com/bin/print_ipub.php?file=/articles/2005/02/03/business/bubble.html
which starts out "Google shares continued to rise ... prompting some analysts to predict that it would hit $290 or more [Google now has] a market value of about $56 billion, equal to that of Starbucks, Nike and Southwest Airlines - combined."

I find it fascinating that the author seems to consider a comparison of GOOG to SBUX, NKE, and LUV to constitute a contrast. Looking at the stats for those three, I find that, respectively, they have trailing P/Es of 49.18, 21.53, and 39.34, price/sales of 3/74, 1.75 and 1.79, and dividend yields of 0%, 1.15%, and 0.12%.

Also fascinating is that Google's price/sales ratio is 21.59. Back at the peak of the first dot.com bubble I managed to find stats for the total sales of advertising in the US, and if I remember correctly the total is not too different from Google's current valuation, meaning that for it to get to a price/sales ratio of 1.0, nearly all the advertising in the US would need to be done through Google.

It is rare for the market to decline from such speculative conditions smoothly down to normal valuation. It usually overshoots to the downside.

http://www.nytimes.com/2005/02/03/technology/03internet.html?adxnnl=1&adxnnlx=1107640938-4RFyAFl4E7CwehNZzUzt3g

It's Maybe a Bubble, but a Selective One
By GARY RIVLIN

The tale of two trajectories among Internet leaders has prompted a debate.

"Of course we're in a bubble again," said Fred Hickey, editor of The High-Tech Strategist newsletter in Nashua, N.H., and a longtime technology stock analyst. But others say that Internet investors have learned to draw distinctions that many failed to make during the dot-com craze.

"The good news here is that investors are certainly proving themselves more selective," said David M. Garrity, an analyst at Caris & Company in New York. "It's not like we're seeing Internet stocks go up wildly across the board. This isn't the 1990's when all a company had to do is put out a barrage of press releases and see the price go up."

John Tinker, an analyst at ThinkEquity Partners, an investment bank in San Francisco, agreed that investors so far were proving themselves far more discriminating than in the late 1990's - even if he detected over-reactions in both directions. "This is a market that is over-rewarding for strong performance and over-penalizing when a company falls short of expectations," he said.

Google's latest stock surge came on the strength of the company's announcement, after the close of the market Tuesday, that its sales and profits grew much faster than expected in the fourth quarter.

Profit for the period was up sevenfold compared with the final three months of 2003. And revenue for the first time broke the billion-dollar mark for a quarter, more than twice the level in the fourth quarter of 2003.

Mr. Tinker says such performance justifies Google's current share price - and then some. "Sure, the share price of Google is high, but we're talking about a company with a revenue growth rate that is accelerating, not decelerating," Mr. Tinker said. "These aren't a couple of guys right out of college talking about how they'll make money down the road."

The company's results seemed to have touched off a bit of one-upmanship among analysts on Wednesday to see who could be the most upbeat about Google, which has now surpassed eBay as the Internet stock with the greatest market value. Among analysts who revised their forecasts, Mr. Tinker projected that Google stock would hit $290 a share within the next 12 months, while Mr. Garrity predicted a price of $300 share "or better."

The company sold shares for $85 each in its initial public offering in August. But while Google's stock price has soared, Internet stocks generally have remained relatively flat. Shares in the Morgan Stanley Internet index have risen 20 percent during the period....

Yet it is Google that raises Mr. Hickey's voice an octave or two. The crucial number for those analysts in awe of Google was its advertising revenue, up 122 percent from the previous year's fourth quarter. The bulk of that is from Google's AdWords program, in which it lets advertisers bid on key words - "asbestos" for lawyers, say - with the highest bidders having their ads appear whenever someone performs Web searches using those words. The bidding can run from 5 cents to $100 a click, according to Google.

"Basically what we're seeing is a temporary land rush going on where legal firms are paying something like $35 a click for words they see as valuable," Mr. Hickey said. "Whether that's economical or not, we don't know. But I suspect it's not because I hear lawyers say it's not worth it at that price.

"What happens when Microsoft is ready to really push its search engine?" Mr. Hickey asked. "It's basic supply and demand. When supply increases, prices fall."

To Mr. Hickey, the result will be 1999 all over again. "Everyone was crazy over banner ads," he said. "Banner ads, banner ads, banner ads. But guess what? It turns out banner ads weren't worth as much as people thought, and the result was that companies like Yahoo saw their share prices fall by 70 or 80 percent."

http://www.nytimes.com/2005/02/05/politics/05benefits.html?ex=1107752400&en=bd5a834b4c8ce11f&ei=5070

Memo Gives New Details on Workings of Bush's Social Security Plan
By DAVID E. ROSENBAUM

Here is a clear description of the way in which the Administration's proposed private accounts system for Social Security would work.

anne:

Moore's law has run up against some major barriers.
Although they continue to squeeze more transistors onto a chip, they are having great difficulty getting proportionate increases in useful throughput. See:
http://www.realworldtech.com/page.cfm?ArticleID=RWT062004172947&p=3
And at http://bwrc.eecs.berkeley.edu/People/Faculty/jan/
http://bwrc.eecs.berkeley.edu/People/Faculty/jan/presentations/LateSiliconDesign.pdf
http://bwrc.eecs.berkeley.edu/People/Faculty/jan/presentations/Lausanne/Lecture1-Rabaey-04.pdf
etc.

[Be polite...]

Anne

Thanks.

I agree with your post. All of your posts are excellent.

What are your thoughts on Japan as the population model?

My greatest concern between now and 2020 is the excess of bonds that may hit the market. Greenspan can't be comfortable with that outlook. I'm not sure that the Administration and the Congress are paying much attention to his advice or Congressional testimony on such concerns.

The lack of analysis and reporting on the likelihood of a convergence of bond requirements creating an excess of available bond sales amazes me.

I fully expect the stock market to be hammered once the excess bonds start flowing, here and abroad.

I don't understand the implications of the "wedge" argument. Let's say 75% of all firms are in the index, and their profit growth is 0.9%. That makes a 0.675% contribution, which means that the other 25% would have to post real growth of 4.9% to make it all equal 1.9%. Do small companies really grow seven time faster than all the index members (which contains, if you use, say, the Russell 3000 or Wilshire 5000, some pretty small players)?

"but these guys(DeLay, Rove, Greenspan) are trying to engineer a great depression in order to overturn the New Deal and completely restructure American society."

That might be their plan. But wouldn't another depression generate the same kind of backlash as the first great depression, resulting in a new New Deal led by Democrats?

Wouldn't they have to end elections first?

Movie Guy and JM :)

Time to read more about demographic matters in Japan and other countries. Brad has a friend who teaches in Spain, Edward Hugh, who regularly wrote on demographics and economics. Now I will consider the ideas again.

About the "wedge," there are a considerable number of significant private and foreign owned companies, as well as small companies, that are not part of the Total Stock Market Index.

Is the number of private and foreign companies so significant that it accounts for more than half of the aggregate profit growth in the US?

This time, they're ready for the collapse. There will be a multimillion dollar advertising campaign (and think how much advertising you can buy after the collapse) to blame the collapse on increasing the top tax bracket to 39.6% during the Clinton Administration.

Bob McManus

The Value Line Arithmetic Index: An equal-weighted alphabetic index containing 1,700 companies from the NYSE, American Stock Exchange, Nasdaq, and over-the-counter market.

The Value Line Geometric Index: An equal-weighted price index containing 1,700 companies from the NYSE, American Stock Exchange, Nasdaq, and over-the-counter market.

Don't assume that inventors are going to bail out the stock market. Inventors make stocks go down because they destroy the price of widgets by making them cheaper, thereby destroying the price of widget factories, thereby destroying the price of widget companies. The only stocks that go up are the pre IPO stock options given to the employees and the equity purchased by the venture capitalists.
What inventors bail out is the bond market, because inventors are deflationary.
For instance, my solar power invention would impoverish natural gas field owners, natural gas drilling equipment owners, natural gas pipeline owners, natural gas electric generation facility owners, and only enrich electricity and natural gas consumers by reducing demand for and the price of natural gas. These are mostly small businesses and residential consumers who do not register on the NYSE or the NASDAQ.

anne wrote, "What I do not find happening now is a slowing of technical advance related to Moore's Law. Information technology is advancing wonderfully as are applications. Will there be serious limits?"

But you're assuming that increased productivity in sectors using computer technology should be linear in the advances represented by Moore's law.

There's zero reason for believing that.

Agreed, but what appears to have happened in the early to middle 1990s was we became adept at translating information technology advances to manufacturing and service sectors. I see applications continuing and considerable work in bio and medical technology in this regard. Am I hopeful on potential for growth? Yes. Hopeful.

Gulliver's Travels

"I was surprised to find corruption grown so high and so quick in that
empire, by the force of luxury so lately introduced,...where vices of all
kinds have reigned so much longer, and where the whole praise as
well as pillage has been engrossed by the Chief Commander, who
perhaps had the least title to either." Jonathan Swift

Much has been said about "framing the debate" since Republican's,
(here we mean evangelical Neo-Con's), first came to office in 1984.
When President-Cabinet-MoC and media talking heads get together,
their debate is polite, a bit "edgy" but non-committal, and comfortably
wrapped before they cut to commercial. That's "framing the debate".
What would you expect of media lapdogs making $B's in income?

See, once you accept WMD's, lockstep voting approval and promise
of UN Aid-for-Buy-in, you get boots on the ground. Then, any sense
of pretext and conjecture is lost. All debate has been framed and the
issue has been "contained", to paraphrase General Westmoreland.
Iraq is now only a military exigency, riding the storm out, in a more-
or-less Israel-Palestine Brobdingnagian way. For our politicians, an
ideal position, flag-wrapped, "no heavy lifting" as Pelosi would say.

"Well, we have to stay as long as we have to stay, and it will cost as
much as it has to cost, and we cannot know the unknowable!" Right?
Then if things don't settle, if an orderly extraction of Iraqi oil wealth into
certain Western-cartel Swiss bank accounts is disturbed, well, then
we'll invade Syria, and make punitative Shock-and-AweTM upon Iran.

All things flow from premise, and framing makes all things possible.
Americans live in a nation ruled by kleptocrats, gangsters and thieves.

So how are we being presented with the invasion of Social Security?
In a word, the ultimate WMD, Social Security is "bankrupt"! Oh Allah!!
Not now, of course, not a discoverable or knowable certainty, but in a
complex projection heavily weighted in favor of the desired outcome,
Social Security may be technically bankrupt some time in, say, 2027.

That is, if nothing changes between now and then. Well, no duhh!

49 of 50 US states are technically bankrupt *now*. US government
is technically bankrupt *now*. Outgo exceeds foreseeable income.
Deficits exceed 3.5% of gross domestic product. Taxes are falling.
Where is the future tax revenue to balance growing Fed spending?
Where is the President's urgency about governmental bankrupcy?
What are the 150 Federal programs that he is going to eliminate?

See, here's what they're not telling you. Here's what you have to pay
a market analyst $1000's a year to read in their tea-leaf projections.

The Baby Boomers are going to start retiring very soon. 40 and out.
They are going to exercise their stock options and roll into secure
income, Treasuries, muni's, and MM. At the same time, as the US$
continues it's inexorable Argentinian melt-down, foreign buyers of
US equities are pulling out. An average 6% US stock yield is ca-ca
if the underlying currency is devaluing at -15% per year, and more.

Low yield bonds and negative yield equities (in terms of a $-basket).
Unmanageable deficit and no increasing tax revenues on the horizon.
US trade position untenable. Global piracy eating in their bottom line.
Corporations fighting for market share of a declining world currency.

So what does that tell you about these Neo-Con's Ultimate Solution?

"Everything is on the table, but THE BEST SOLUTION IS privatization."
GWBush. (Round up the goyem, and put them in Wall Street gulags.)

I'll leave it to you to guess their motives. I don't hold any fat stock options.

If we let Neo-Con's frame this SS debate, we'll be left living like the Iraqi's.
If we let Neo-Con's cut everyone's benefits, and add -$4T in deficits to our
Trust, just so the US equities markets can hold their value for a cash-out,
then we're no different from some 3rd-world client state, campesanos all.
If we let Neo-Con's privatize our Trust, then we deserve the cardboard box,
and the pushcart, and the dumpster. Get involved with AARP and your MoC!

Our Social Security Trust Fund is a *trust*. Every MoC owes each of US
their *fiduciary* responsibility to balance that Trust, and earn a yield at
some multiple of inflation and US$ devalution, just as in any trust fund.
This is not puts and calls, hedges and spreads, this is an equity trust!

So do the math, crunch the numbers, develop the options, then put it all
on the table before the American people, and vote the referendum in '08.
Then MoC's will have actuals and our plebiscite to guide their decision.
Anything less than this full disclosure is "framing", and shall not stand.

Fredbear: "Get the government out of your life."

To Fred:
Please refrain from driving on public roads, drinking from publicly-treated water systems, and using the publicly-developed internet, please.

anne wrote, "I see applications continuing and considerable work in bio and medical technology in this regard."

Hmm...I'm skeptical.

Actually, there could be a large increase in productivity in the medical sector with appropriate application of medical technology, but it would necessarily involve a change in the "industrial organization" of the sector and a decrease in economic rents received by physicians, who currently perform their work using a medieval guild structure. And they have lots of political influence with which to oppose any changes.

Biotech: people have been waiting for the biotech revolution for more than a decade now. As it was put in _The $800 Million Pill_, much (if not most) of the low-hanging fruit in this area has been taken. Biotech will eventually pan out, but it's much harder than people think it is. (Witness the recent debacle involving COX-2 inhibitors.)

anne wrote, "Agreed, but what appears to have happened in the early to middle 1990s was we became adept at translating information technology advances to manufacturing and service sectors."

The other thing that happened in the 1990s is that hedonic and substitution adjustments began to be applied to inflation measures. There's a lot of skepticism surrounding these adjustments.

If you return to the previous measures of inflation, productivity and GDP growth aren't nearly as rosy as they are currentedly purported to be.

Liberal

There is reason for you to be critical on each point. I am less inclined to worry about using pricing that accounts for quality changes, more inclined to worry about bio and medical technology applications increasing productivity. We must think.

Posters are confusing the P/E ratio and the dividend yield. The PE ratio right now is 20-23. High but way down from the bubble. Earnings---to the extent to which there are honest accountants---is a real economic variable. Dividends, on the other hand, depend on dividend policy of corps. Dividend yield has been trending down since 1995 at least. And in fact has been rising since the bubble burst.

Dividend yield (and its inverse price/dividend ratio) is way out of historical line, but this isn't news. It has been true for a decade. Given that the P/E ratio is much closer to the historical average of 16, the question is has corporate policy changed? Not is it time to buy gold and head for the hills.

Dear Brad

Great post.
I haven't read the other comments sorry. I particularly liked " minus a 1% wedge because a goodly share of profits are earned by young companies not yet in the index)." but I would put it a bit differently as "minus a 1% wedge because a growing share of profits will be earned by firms which do not now exist or are too small to be included in the index". The point is that the share grows not that it is large. Actually
" minus a 1% wedge because a goodly share of *future* profits *will be* earned by young companies not yet in the index)."

Philip: I don't think anyone is confused. The point is that dividends are, by definition, limited by profits. The maximum imaginable dividend is if all profits were paid out in dividends. hence, E/P.

Okay, who exactly is buying short and saying all this stuff?

[troll]

Think about small stocks.