Since 2008, stocks have been on the rise. I am not an economist, but I would expect that the perceived value of a company is based on the demand for whatever product or service the company provides, ignoring bubbles. While the economy is slowly recovering, I keep hearing news about millions of Americans who have simply left the workforce, millions of others who can’t find work and millions of others who wound up taking large pay cuts. Do these numbers represent a minority of Americans while purchasing power for most has increased? I can’t believe that the ranks of the rich are large enough to be driving the economy. Another possibility is that the market is massively overvalued. I don’t hear that as a common complaint though. So what’s at work here?
There are lots of reasons. First, interest rates are very low so stocks look like a better investment.
Second, there are piles of cash out there, and they have to go somewhere.
Third, market prices are based one expectations of future earnings, and with the economy definitely improving, stock prices rise.
Fourth, if companies are sized to make a profit even given the high unemployment and relatively low demand you mention, they won’t affect stock prices.
Finally, some may be due to relief that the government is unlikely to shut down and default any time soon - but I’m not sure about this one.
I don’t recall seeing much that says P/E is terribly out of line, but I have seen some people predicting a correction, so it may not last.
Well, kind of. Investors buy if they think that a stock will go up and sell if they think a stock will go down. Clearly there should be a relationship between a stock’s performance and the demand for the product, but there are other things that come into play. For instance, if there’s a tight supply of something, prices will rise and that’s good for the stock. Oil company stock generally does well when supplies of oil are tight.
Then there’s government spending. When consumer spending fell at the start of the “Great Recession”, the federal government tried to rescue the economy by spending huge amounts. Much of that money went to corporations. Government spending today is lower than in 2009-10, but still well above historical norms. Good times for the companies that get government contracts, in other words.
Lastly, of course, investors often do irrational things. During the dot-com boom of the 90’s, everyone was buying up stock in Netscape and Furniture.com and other companies that had no hope of ever turning a profit. They simply assumed that the stock would rise, and that they’d be able to dump it on some other fool and make money that way. And of course it worked, right up till the moment when it didn’t.
Obviously when buying a stock you mostly hope the share price goes up, but often shares are purchased as part of a larger overall strategy that goes way beyond simple ‘I think this will go up’ thought. Maybe it’s to diversify a position. Maybe it’s to buy back shares that you shorted previously. Maybe it’s part of a basket trade. Maybe you’re a passive PM and you’re re-balancing your portfolio. Maybe it’s a stock that you think won’t do jack, but it offers a safe, stable dividend. Maybe you merely think the stock will do better relative to whatever index you’re bench-marked against.
Oil stocks tend to do well when they have meaningful and cost-efficient production capacity in the areas where supplies are short. A company that fails to trim costs, innovate logistics infrastructure, or invest in new machinery will find that its share price tanks even when supplies are tight, because other companies are in better position to ramp up its own production just as overall inventory slips.
Voyager, interest rates have been low for a rather long time - in the US, since late 2008, for instance, or even long before that in Japan - so clearly there’s a lot more at work than interest rates. Japanese equities only finally rallied from late 2012 primarily on signs that the new government was serious about stimulating inflation.
I have my own theories on the equity markets…but since I’m paid to write 'em I’m not giving 'em out for free here
In addition to some of the points made above, a lot of companies have coped with the economic downturn by sacking a lot of employees and making the survivors work for lower compensation, both in salary and benefits. This does not do much to help the economy or affected people (at least in the short term) but it does make those companies more profitable and helps their stock prices.
Of course there’s a lot more than just interest rates. But interest rates are a big deal too.
Your point would be more valid if the comparisons were being made to just 2008 (and to respond to that, one would have to point to future expectations in 2008). But if you’re talking about current P/E ratios versus historical averages, then you need to view that in the context of current interest rates versus historical averages. (Which, of course, could become a big deal if interest rates rise.)
Sure. Back in 2008 fear drive a lot of money into Treasuries, right? And it is not like all the money flowed into the market at one time.
Krugman has been advocating higher inflation targets for a while now. I don’t know if the run up after the tapering announcement is from the possibility of inflation growth or from the vote of confidence in the economy it represented.