Ben Bernanke published a defence of US Federal Reserve policy since the crisis on his Brookings Institute blog on Monday.
What caught my eye, and those of many traders, was his assertion that:
Stock prices have risen rapidly over the past six years or so, but they were also severely depressed during and just after the financial crisis. Arguably, the Fed’s actions have not led to permanent increases in stock prices, but instead have returned them to trend.
To illustrate: From the end of the 2001 recession (2001:q4) through the pre-crisis business cycle peak (2007:q4), the S&P500 stock price index grew by about 1.2 percent a quarter. If the index had grown at that same rate from the fourth quarter of 2007 on, it would have averaged about 2123 in the first quarter of this year; its actual value was 2063, a little below that.
There are of course many ways to calculate the “normal” level of stock prices, but most would lead to a similar conclusion.
Leaving aside the fact that the period he chose as a base covers the years where there emerged in economic, market and central bank circles a misplaced belief that the business cycle had been defeated, something Bernanke himself called The Great Moderation, the arbitrary nature of this observation is ridiculous.
Trends emerge and continue over many years.
Bernanke’s observation that if you extrapolate the trend from this time into the future is broadly correct.
But, the choice of a period of market gains in such a short window in history, and also a period which is largely now both blamed for the policy settings that that led to the global financial crisis, seems disingenuous.
But as noted above Bernanke says that “there are of course many ways to calculate the ‘normal level of stock prices, but most would lead to a similar conclusion.”
We could extrapolate a trend since the start of the grand bull market in 1982 to 2007.
But that renders a “valuation” in the 1800s. Is that close enough for Bernanke?
Now, we all know that charts and statistics can be made to tell any story we want. Which is kind of why Bernanke has chosen the period he has.
But if we actually include the prices since 2007 and including the crash of 2008/9, and subsequent sharp recovery we end up with a very different picture of “valuation”.
Including the data for Bernanke’s favoured period, and then from 2007 to the present, leads to a trend estimate for the S&P of around 1,700. A similar exercise for the data from 1982 renders a similar result.
Thus by Bernanke’s own logic the S&P could be seriously overpriced at the moment.
That’s not to try and predict a crash.
But, as Yale Professor Robert Shiller pointed out overnight the reason Bernanke is trying to justify the current price for US stocks is that there as been a big fall in investor confidence in the valuation of US stocks.
“The fact that people don’t believe in the valuation of the market is a source of concern and might be a symptom of a bubble, though I don’t know that we have enough data to provide it is a bubble,” he said.
Bubble or no bubble, by many measures stocks look expensive. As Henry Blodget noted over the weekend by some measure they are both “frighteningly expensive and risky” at the moment.
Ben Bernanke has fit the data to his narrative. That’s okay, we all do that sometimes, but the period he chose to do it was the most ridiculous one he could have used.