Are Stocks Cheap? Will They Get Cheaper?

Martin Wolf in the Financial Times tells us, "Why fairly valued stock markets are an opportunity." With the above graph, he looks at the long run fluctuations in Tobin's Q and cyclically adjusted P/E ratios. He gets the former from Andrew Smithers. The latter comes from Robert Shiller.

To my eye, it appears that long run market trends are associated with inflation regime shifts: the World War I inflation, the resumption of the gold standard, Bretton Woods, the Great Inflation of the 1970s beginning in the mid 1960s, the Vocker retrenchment, and the Greenspan punchbowl (i.e., "We do not prick bubbles and we live in fear of the demon deflation." The traditional role of the Fed was to take away the punchbowl just when the party got interesting.)

The valuations in the 1940s and 1950s may be understated, particularly for Tobin's Q. The government accelerated the recognition of much capital investment as part of the war effort in World War II. some economists believe this led to an underestimation of the capital stock and perhaps also an understatement of reported earnings and equity.

How sanguine should we be? Wolf concludes, "investors with long time horizons (the relatively young, or institutions) are, for the first time in almost two decades, confronting attractive, although not sensationally attractive, market valuations. ... nevertheless, formidable pressures for further falls in valuations, as leveraged players continue to be forced to offload assets at bargain prices."

Even GDP Numbers Are Now Showing A Widening World Recession

The U.S. economic recession which began in the summer of 2007 is starting to manifest itself in published GDP growth data.

The Financial Times and the Wall Street Journal report that GDP fell .5% in the third quarter. Since inventory investment added almost one percent to GDP growth, final sales must have fallen at close to a 1.5 % annual rate. Read details in the press release on the BEA website.

Import prices rose almost sixteen percent. For a country importing close to two trillion dollars of goods and services, that is equivalent to America's losing rough $300 billion in purchasing power. Talk about negative stimulus to aggregate demand!

Norma Cohen, FT's Economics Correspondent, reports the Organization for Economic Co-operation and Development (OECD) "is now forecasting four consecutive quarters of contraction for the US, countries using the euro, and OECD nations as a whole."

The Demise of Morgan Stanley

When Glass-Steagall forced J.P. Morgan to separate his commercial banking from his investment banking operations, he spun off the investment banking into what is now Morgan Stanley.

Susan Pulliam, Liz Rappaport, Aaron Lucchetti, and Jenny Strasburg chronicle Morgan Stanley's death throes. Evan Newmark tells us how greed did in Morgan Stanley writing at the Deal Journal on the Wall Street Journal's website.

Bretton Woods II and International finacial Regulation

Martin Wolf argues that agreeing on a new Bretton Woods is vital. Indeed, "The Great Depression of the 1930s was accompanied – and aggravated – by failures of economic co-operation, disintegration of the global economy and resurgent nationalism"; and cooperation is necessary now. Indeed Carmen Reinhart and Kenneth Rogoff argue that political interference played a major role in the curretn financial crisis and that "the need for greater regulatory independence is a compelling reason for establishing an international financial regulator."

Thinking About the Next Bubble

Gerald P. O'Driscoll, Jr. tells us, "To Prevent Bubbles, Restrain the Fed."

It is time to think past the crisis. When Alan Greenspan worried about deflation (falling prices), he kept interest rates too low feeding the investment bankers in the great credit over expansion of the mid-2000s.

How will we soak up all the excess liquidity that could fuel the next bubble?

A Little Country with a Popuation less than Sedgwick County Is at the Center of the Financial Crisis

Robert Jackson writes a "Letter From Iceland" in the Financial Times, "Think of Ireland. Rotate it 90 degrees clockwise, make it a third bigger and hang it like a pendant from the Arctic Circle. Crack open the earth’s crust below to release limitless supplies of geothermal steam, then fill its territorial waters, all 200 miles of them, with an abundance of cod. [read on]"

The Wall Street Journal shows us protests in Iceland:

Speech by Federal Reserve Chairman Ben S. Bernanke : "The Future of Mortgage Finance in the United States"