In the current bull market that we are in, is the dollar value of the market a real dollar value where the money actually came from somewhere else (funneled/siphoned from somewhere else in the economy)? Or is it an artificial value?
And if it is an artificial value what effect does it have on the value of the dollar? Does the value of the dollar actually decrease in a bull market?
Simple answer is the economy is growing and thus there are more dollars to be had, thus the stock market goes up. One sign of this is that the unemployment rate is as low as it has been in years. Also the value of the dollar can be tied to how it exchanges with other currencies, doesn’t appear that we are hurting in that aspect. And inflation hasn’t taken off, another good sign. I’ll leave it to others that like to discuss the economy in great detail to go into lengthy explanations and rebuttals.
Another short answer is that since we went off of the gold standard the whole market is artificial and a house of cards waiting to fall at anytime for the most trivial reason, like a bad news report.
What dollar value are you referring to, and what is your definition of “real” and “artificial?”
The value of the stock indexes at any current moment is calculated in various ways from the individual values of the stock comprising that index. The DOW has only 30 stocks, the Standard and Poor’s index 500 companies, and the Wilshire 5000 obviously has … wrong, it has 3,492 components because of mergers since when it was first devised.
The price of a stock is a speculation of the net present value of the company, how much a company would be worth in the future when the stock is sold. Theoretically, at least. That speculation changes at every moment as different buyers enter the market which is why stock prices fluctuate moment by moment.
The sum of all stock prices is the capitalization of a company, known as the market cap. Yes, if stock prices go up, money is created out of thin air. If they go down money is removed. None of it is real except the value of the individual stock that has just been sold. All value works this way. It always has. Even under the gold standard. Money is always artificial: it has the value of what people are willing to consider it at any moment. Currency is not money. Currency always has the same denomination, but what you can get for that denomination always fluctuates itself moment to moment as prices change.
Keep in mind that a loan is actually a time machine, transferring money from the future to the present.
(When I loan you $1000, I have an asset worth $1000 and you then go and buy an asset worth $1000. As you pay me back, the money pops back into the future.)
Also consider that dollars, like wheat or pork bellies or iPhone X’s, is something that is worth the value others put on it. When everyone wants them, the value goes up. The central banks’ job is to trickle cash into the economy at just the right rate that you don’t get deflation - money is hard to get, so people can’t sell and have to lower prices - or else inflation - everyone is flush with cash so you can charge a higher price. The cost of loans (interest rate) plays a significant role in the availability of money too.
And it’s quite possible that the Chines, who have problems of their own and may be smarting a bit from the new trade restrictions, will start selling dollars which will bring their value down. The effect of this will be to make imports more expensive.
- If the value of all types of assets goes up, which is generally the case in recent years worldwide, it makes most sense to view that as newly created value. After all in the very long run nobody (I hope) thinks the total value of things (any way you want to measure) has never changed. Obviously it has generally gone up, enormously compared to centuries ago. So nothing weird if it moves up a little today v what it was yesterday.
That’s the ordinary result of human effort, advance in knowledge, population growth, etc.
-
What would be examples of ‘artificial’ and ‘non artificial’ values?
-
However the answer to the meaning of ‘artificial value’ goes, there’s no strong connection historically between the value of the US dollar v other currencies and the total value of the US, or world, stock markets expressed in any single currency. The two things can influence one another at the margin. The tricky part is usually in trying to say if or which one causes the other.
For example in the last year the US stock market has gone up strongly expressed in USD terms, but the USD generally declined expressed in terms of most other currencies. That’s not always so when the US stock market rallies, but in this case that it has been. It means the US stock market doesn’t look as much more expensive in say EUR terms v a year ago as it looks in USD terms (at least not absolutely, relative to USD earnings it still might). So at the margin that’s more of a reason for EUR based investors to keep buying US stocks. Also, a weaker USD makes the foreign currency profits of US companies look bigger in USD, so that’s a boost to the attractiveness of US stocks from a USD POV. OTOH a fall in the value of the USD if it were due to loss of confidence in the US economy would be a big negative for US stocks, that loss of confidence would. Why do we say that’s not the case (if we don’t)? Because the US stock market is rising. So to some degree it’s always just tea leaf reading to say exactly why the market does what it does, the market does what it does. Anyway there is no single deterministic mechanism which always ties the value of the US stock market together with the foreign currency value of the USD in the same way.
Question is a bit vague, as others have answered. In my reading, I would call it an artificial value. If the last recorded transaction of stock x was at $100, we would say that each share is now worth $100. The assumption is that all holders can sell their shares at $100. This may or may not be true. The current holders of shares of stock have paid various prices for it. So the $100 “value” didn’t come from anywhere concrete.
In other words, what Expano already said…
This is not true. I realize you may be using ‘money’ in a loose or colloquial way, but I think a lot of confusion about this question (and I hear variants of this question quite often) comes from confusing money and value. Money (in a US context) is the sum of all the dollars that people and institutions have. Not necessarily physical dollars (paper and metal) but also including dollars that only exist as records in bank accounts. Because of fractional reserve banking, the actual supply of dollars can fluctuate, and there are different measurements. There is no one answer to how many dollars there are. (The wikipedia article on money supply is quite accessible - read it if you’re interested!) But none of the measures of money supply include the value of company stocks or tangible items. I may increase the total amount of value of goods in the world by whittling an owl out of a block of wood, and I may even be richer since I now have a fantastic work of art in my possession, but I haven’t created money by doing so. Similarly, the increase in market cap of stocks may truly represent an increase in underlying fundamental value (productive capacity of the private sector), but it doesn’t mean that any money has been created.
In the US, the Federal Reserve can create money by buying bonds on the open market (the Fed really just wills those dollars into being) or by decreasing the reserve requirement for banks that are lending (or by lending reserves to those banks, again willing those dollars into existence.) This action doesn’t create any tangible value - those concepts are separate. The Fed generally wants to keep money supply growing (over the long-term, but not necessarily in the short-term) at a rate such that the amount of tangible value you can acquire with a single dollar decreases slightly over time. IE, inflation.
FWIW, on the ‘real’ value vs. ‘artificial’ value distinction: those aren’t rigorously defined terms by any stretch, but I would probably opine that it’s ‘real’ value to the degree that the bull market is reflecting an actual increase in long-term, sustainable productive capacity of the economy, and ‘artificial’ value to the extent that it is reflecting speculative excess. My IMHO is that we’re very much into the territory of the latter, but again, imho…
Yeah, I used the term money just because it was the OP’s word. I did put in an allusion to value toward the end. Money is just the arbitrary way we measure value; it’s not the same thing. Nor is there a good evaluation of how much value the world contains. People try to make estimates of valuation of certain more easily measured things, but even basics like GDP are dicey.
That could be a reasonable definition in theory or ‘real’ value, not a reflection of speculative excess. The problem in practice obviously is determining what’s speculative excess. The more honest and reasonable valuation bears at any given time admit that valuation metrics are a historically poor predictor of short to medium term returns. Then in the longer term say for example high Cyclically Adjusted P/E ratio’s correlate somewhat meaningfully with subsequent 10 yrs returns, a) it’s only somewhat, b) high CAPE tends historically to correlate with a low positive return over the following 10 yrs, not necessarily a negative one. And what exactly is the ‘artificial value’ now if the expected return on stocks is low due to high valuations, but there’s nothing else you can invest in that doesn’t have low expected returns due to high valuations? Which is generally the case now.
Only in hindsight can anyone really say a valuation was ‘artificial’, not that practically meaningful a term therefore.
The other thing to note is that the stock market doesn’t strictly speaking measure the ‘productive capacity of the economy’ even in the long run. Especially not if people establish corresponding categories of ‘real production’ v ‘artificial production’. As in for example preferring manufacturing over financial services dollar for dollar in economic output.
And even if they just measure the productive capacity in GDP $'s, there are still significant factors like tax treatment. For example the corporate tax rate cut in the US became a clear positive for stocks once it appeared likely (which goes back to the surprise outcome of the 2016 election, not the arbitrary start date of the current administration or day the bill was finally passed). Stock values reflect the pre-personal tax (on investor) value of the after (corporate) tax earnings of companies. Cut the corporate rate and that creates a strong updraft in stock prices that it takes a lot of damage to the real economy from bad effects of that tax cut (if any) to undo. It doesn’t mean the tax cut is good for society overall weighed on a person by person basis rather than a dollar by dollar basis of stock prices. Those just aren’t the same thing. But a lot of people don’t switch gears from politics when they start talking about stocks.
I agree with this completely, which is why I was careful to sprinkle an extra heaping of IMHOs in my post.
You should probably show your work here. It would appear that for sufficiently high PE/10s, it does correlate with a short/medium-term negative return. You run into the problem that the higher the PE/10 you look at, the fewer data points you have to consider, but I’m open to a mathematical treatment of the concept.
I didn’t say measure; I said reflect. In the sense of ‘in the short term, the market is a voting machine; in the long term, it is a weighing machine.’ That long-term weight is a reflection of the overall productivity of the economy.
Here, you’re mixing up short-term and long-term factors. It’s true that the corporate tax cut makes corporate profits look healthier now, today, but it’s not exactly free money. That’s money that is no longer available to federal government to invest in national infrastructure, defense, and the welfare of its people. And if the federal government does continue to spend that money, it comes via borrowing, competing for lendable funds and raising the borrowing rates down the line for the private sector. These effects manifest in the long-term.
- This qualifies IMO as common knowledge, the straight forward observation of very few if any billionaires who got that way consistently short to medium term trading the stock market based on CAPE or any other valuations measure. But for general exposition purposes here’s a article with graph of subsequent 3yr return of US stock market v CAPE. It’s a largely shapeless cloud you could only torture to give you any real inference. And it’s a sparse cloud at the current level of CAPE, red box.
Shiller P/E Versus Subsequent 3-Year Real Equity Returns - Business Insider
Also CAPE (though it was just one example to give an idea what I’m speaking of in general) has significant issues of comparability over time as accounting practices have changed, different interest rate environments too. I really don’t agree it’s some novel point of mine that a single valuation measure like CAPE is of very limited use predicting short term returns.
- And again my point is that that can break down in a lot of average people’s (and therefore the political system’s), definition of ‘productive’. Additional factors I didn’t even include before are things like
a) 40%+ of sales of S&P500 companies are outside the US (a profit breakdown is more subject to deliberate management of where profits show up). So ‘the economy’, but which one?
b) over time and among countries the proportion of overall profit on capital captured by publicly traded companies varies. For example there’s been a historic explosion of wealth in China in recent decades but mediocre returns for holders of publicly traded companies. Most of the added value has gone to owners of private concerns, managements, etc. Although less dramatically, this can be a significant factor in developed markets also.
c) the % of overall value added that’s captured as profit on capital (private or public companies) rather than wages can vary. Among the reasons for economic discontent with high asset prices is that profits on capital are a higher % of GDP, and a wages a lower %, now than they used to be.
I’m not quarreling with the basic vague, theoretical idea that under certain assumptions the value of the stock market would measure the ‘productive capacity of the economy’, just pointing out practical exceptions significant enough to seriously discount the practical usefulness of the observation.
- I’m not mixing up anything. I am making the simple statement that a lower tax rate on the same profit means a proportionally higher stock price. And we saw how that works in early Nov '16 to recently. There’s never ever a real market case where nothing else is going on, but in some cases a driver is pretty clear, and this was one. That’s a simple deterministic relationship, assuming profit is constant.
I explicitly mentioned the possibility that a low corporate tax rate as part of a whole different tax policy could do damage to the real economy over time, ie perhaps lowering pre tax profits (from what they’d have been otherwise). But firstly such predictions are speculative and tend to be politics-heavy (a lot of people want a particular tax policy to succeed or fail to fulfill their political preconceptions, either way, that tends to wash out in the decisions of smart money which move the market). And secondly yes, no confusion here either, the potential negative effects only play out over time. And time means uncertainty. As opposed to almost no uncertainty that year 1’s after corp tax profit is higher if the tax rate is lower, not much for year 2, etc in the shorter term. What may happen many years hence is less of a factor unless it was obviously very deleterious. But it’s not really so obvious, with political hat taken off. It’s quite uncertain. So unsurprisingly the short term deterministic relationship wins out in the short term: corp tax rate lower, stock prices higher.
Interesting scatter-plot. The optimistic ("Yes!) part of the plot is part of a trail which presumably came from a single episode (of 3 to 4 years duration, bubble to crash). Anybody know when that episode was? (I’ll guess it was late 1990’s: unless I’m suffering brain-fart the 1998 data was right there at the Yes! arrow. It wouldn’t be hard to duplicate that scatter-plot, but I’m feeling lazy.)
I am a bit suspicious of predicting future market behavior from the past. The market makers and regulators move on. They’ve got yesterday’s problems solved by now; it’s tomorrow’s problems that will catch us! 
Seems like we’re getting to the very basic and profound questions about “what is an economy”, “what is value”?
Essentially, any person or group of people who make something, create value. Even without money, this exists - if Ogg is good at making bows and clubs, everyone will come to his hut and trade chickens for weapons and he will have more chickens than he knows what to do with. (Money just makes it easier to put a value on things, because it can be traded for just about anything.) Every day that someone does something productive that is useful to themselves or others, they create value. The more saleable (tradable) the item, the more value it creates. And every day value disappears are useful items break, wear out, or if services, the service ends, etc.
Money is a medium to exchange value so people can obtain the items they need, in accordance with the value they produced. If there’s too much money for the value of goods floating around in the economy - as happens in Venezuela today, Zimbabwe over the pat 30 years, or Germany in the 1930’s, etc. - people raise prices because the money has less value. If there’s not enough money availabl, people don’t buy new cars or large steaks, the suppliers cut back production or prices.
The central banks are supposed to monitor their economy and judge whether money is becoming too scarce or too abundant, and change how much they add to the economy to maintain stable-ish prices.
So is the current dollar value real? Well, yes, because people are willing to pay that. But, is the value based on real “value” or speculation? In most bull markets, a lot of the price rise is based on speculation… “I better buy Amazon or Apple today because I think it will be worth a lot more in 5 years.” When the “value” is guesswork, no the value is not “real”. When the value is based on today’s activity and short-term trends it is real. Apple can sell an iPhone for a 50% mark-up whereas the profit in automobiles is generally nowhere near that, and the profit in newspapers even worse. But everyone wants to buy Apple, so there’s a surplus of money chasing a shortage of stock and the price is bid up, thanks to a fairly efficient market.
If like the 2008 housing market, the value is suddenly lower, nobody wants to buy that item, *then *value disappears. In 2008, a lot of property was purchased on speculation, “the resale value will be even higher in a year”. Until then, others will buy it at the perceived value, so that’s what its’ worth. perhaps a better OP question is, is the current value of stocks overall justified by current production rather than mostly based on guesses about a few years from now? My totally uneducated guess is the answer is about 50-50.
Thanks for the link.
This paragraph is a pretty good example of a repeated pattern of your posts in this thread: you are taking things I’ve said, extrapolating from them in ways I don’t intend, and then making arguments against those extrapolations. For example, I’ve never claimed that consistently making short-term trading decisions based on PE/10 is a path to success. Only that when PE/10 gets outside of certain bands, it starts to become reasonable to use it as an input to investment stature. Let’s take the scatter-plot in the article you linked to: I disagree that it is a largely shapeless cloud. It has a clear downward direction as PE/10 increases, and that’s before correcting for the obvious flaw: the downside is more extreme than the upside, even in percentage points, and a 35% loss is generally considered to be much worse than a 35% gain is good.
Furthermore, the article is from mid-2015, when PE/10 was 27. Today it’s 35. At 27, I took the author’s advice: don’t panic, but expect lower returns going forward. I think different advice attaches at 35: start seriously thinking about lessening your exposure to stocks. Keep powder dry for when stocks decline. Is this a guaranteed path to success? Of course not, nothing is, but it still seems to be good advice.
But not really what this thread is about. This thread was asking if the increase in market capitalization represented ‘real’ value or ‘artificial’ value, but didn’t define those terms. I opined that it’s more likely than not to be in a time speculative excess, and to the degree that it is, that is ‘artificial’ value. I’m not making any attempt to quantify that, nor quantify concepts like ‘overall productivity of the economy’, nor am I trying to apply all the correct adjustments to that value due to international trade, currency fluctuation, etc, nor need I to do any of that for the point to be valid.