17 August 2014

An Open Letter to Dr. Shiller [update]

In today's Times Business section, Robert Shiller gives his take on stocks, specifically the question: are they priced too high? He titles the piece (dead trees version), "The Mystery of Lofty Elevations". The web title is similar.

Note, of course the use of the word 'mystery'. Are stock prices really too high? As I've been arguing for some time, NO. Those with piles of moolah to 'invest' have traditionally been in bonds, clipping coupons each quarter. Living off the interest, in simple terms. As even Dr. Shiller has to know, short term interest rates (in particular, the Fed Funds rate) are not what determines long term (corporate) interest rates. The value of corporate bonds is determined by the return earnable from new plant and equipment in the hands of 'job creators'. To the extent that 'job creators' choose to not buy plant and equipment, at any rate of interest, then the long term return to moolah holders will go down.

There's also the matter of the supply of loanable funds, aka "The Giant Pool of Money". It's still around, and corporations continue to hold ever larger amounts of idle cash. They'd love, I'm sure, to be given 10% annually by Washington or Bejing, but that ain't gonna happen. Until such time as the 'job creators' decide that physical investment is more lucrative than fiduciary games, the supply of long term funds will outstrip the demand for such. It's that simple. So far, their notion of smart capital allocation is to stuff it into the mattress.

The Captains of Industry have simply run out of ideas. The digital economy is, on the whole, super-cheap to run. Even as we approach the next (and, perhaps, last) barrier to continuance of Moore's Law (for myself, it looks like physics has repealed the law), the cost per cycle continues to diminish. In any case, the web economy amounts to little more than giants and dwarves fighting over advert buyers and advert clickers. Arabs, and their blue eyed Texas brethren, learned the hard way that you can't eat oil. The web economy will eventually realize that advert peddling is just a lot of wheel spinning; much ado about little.
So I've been trying to come up with a theory to explain today's elevated stock prices -- and maybe convince myself that they could remain lofty for some time. One factor to consider is that bond prices are high, too.

It's as simple as I've said: bond prices are high (yields low) because the Captains of Industry aren't smart enough to figure out new ways to turn moolah into machines. Even with money available at historically low rates, and retained earnings at historical highs, the Captains just don't know what to do with it.
When there aren't enough good investing opportunities, people wishing to save more for the future may succeed only in bidding up existing assets even if they think they're overpriced. Call it the "life preserver on the Titanic" theory.

And, in other words, all those Koch Brothers types who bleat that Americans have to save and invest more ignore the plain fact that corporate America hasn't been able to allocate The Giant Pool of Money that's already sloshing around. Push more money into the Pool, and returns will fall still further. Econ 101.

We can expect yet more bleating from the .1% class that capital gains taxes are ruinous. Why? Since they can't get by on the low coupon returns, they must needs turn to stock price appreciation (as we've seen) and share selling for income. And, of course, since only Little People pay taxes, their incomes shouldn't be taxed. Just watch.

Seems some of the sell-side analysts (larger fish in the pundit pond than I, alas) take exception. This shouldn't be too surprising, since they make their obscene incomes flogging stocks. But they do have a salient point: they tout forward P/E, while Shiller's CAPE (where's Superman when you need him) is explicitly backward looking and for a long time at that. The notion that more data is better is generally a good thing, except when there's been an inflection in the data of your model, and worse if the inflection is in the recent past. The evidence is clear that the Captains of Industry are using fiduciary capital in more financial engineering exercises and less in buying plant and machines. No physical investment, no hard returns to capital, no interest earned, no demand for additional capital. The causation is that long term earnings determine short term rates. Central banks can hope to manipulate short term rates, and even set one or two, but they can't change the course of science and engineering (the real kind). Without tech progress, there's only foregone consumption to pay the vig. Looking at 21st century economies through the lens of 19th century experience (even to mid 20th) is folly.

It isn't a fluke that The Giant Pool of Money (larger now than then) was dumped into non-productive real estate. The Captains of Industry had no use for it. They still don't.

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