>Dean Baker of the Center for Economic and Policy Research was the first
>economist to work through the arithmetic of this "bubble" market
Ahem. December 1998:
<http://www.panix.com/~dhenwood/AntisocInsec.html>
>Stock answers
>
>But let's take the 1.4% growth projection and apply it to the stock
>market, that cornucopia of wealth that's supposed to replace the
>public pension system. Privatizers typically assume an average real
>stock market return of 7% a year, from the combined increase in
>prices and the cash dividends. How the stock market is supposed to
>grow five times as fast as the economy is a mystery that's rarely
>noted, much less investigated. To achieve those stock returns, the
>ratio of stock prices to underlying corporate profits --
>price/earnings (P/E) ratios, a fundamental measure of whether stocks
>are "expensive" or "cheap" which goes out of fashion at enthusiastic
>times like these -- would have to rise to astronomic levels.
>
>The stock of all U.S. corporations is worth roughly 26 times their
>collective profits -- the highest since 1945, and twice the
>historical average, meaning that stocks are very expensive by stodgy
>old measures. But today's P/Es would be nothing compared to
>tomorrow's, if stocks truly were to return that 7% for the next 77
>years (4% in price appreciation and 3% in cash dividends) while the
>economy was growing at 1.4%. If profits grew in line with GDP while
>the stock market were growing at five times that pace, P/E ratios
>would rise to 33 by 2010, 71 by 2040, and 178 by 2075. But wait!
>Dividends can't grow any faster than the economy, can they?
>Constraining those to the 1.4% assumption too means that stock
>prices will have to rise even faster to compensate for the lower
>growth in dividends over time. That would give us a P/E of 138 by
>2040 and 764 by 2075. When you work for the Cato Institute, you're
>never called upon to defend your preposterous reasoning.
But then again, I'm not an economist.
Doug