There is no stock market bubble

The bigger question is whether rock-bottom interest rates will revert to ‘normal’ and, if so, when

Martin Wolf

   © James Ferguson


Are stock markets, especially the US market, in a bubble that is sure to pop? The answer depends on prospects for corporate earnings and interest rates. Provided the former are strong and the latter ultra-low, stock prices look reasonable.

The best-known measure of market value — the “cyclically adjusted price/earnings ratio” of Yale’s Nobel laureate, Robert Shiller — is indeed flashing red. One can invert this metric, to show the yield: on the S&P Composite index, this is just 3 per cent today. 

The only years since 1880 it has been even lower were 1929 and 1999-2000. We all know what happened then. (See charts.)


Another price is also exceptionally low by past levels: interest rates. The short-term nominal interest rate is near zero in the US and other high-income economies. 

US short-term real interest rates are about minus 1 per cent. Real yields on US 10-year Treasury-inflation-protected securities are minus 1 per cent. In the UK, yields on similar securities are about minus 3 per cent.

Desired returns on equities ought to be related to the returns on such supposedly safe assets. This relationship is known as “the equity risk premium”, which is the excess return sought on equities over the expected returns on government debt. 

This premium cannot be measured directly, since it only exists in investors’ minds. But it can be inferred from past experience, as explained in a 2015 paper by Fernando Duarte and Carlo Rosa for the New York Federal Reserve. 

More recently, in the Credit Suisse Global Investment Returns Yearbook 2020, Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School estimated the excess return on world stocks over bonds at 3.2 percentage points between 1900 and 2020. For the UK, the excess is estimated at 3.6 percentage points; for the US, at 4.4 percentage points.


Are these excess returns in line with what people initially expected? We do not know. But they are a starting point. The premium demanded now might be lower than that sought for much of the past 120 years. 

Corporate accounting has improved greatly. So, too, has macroeconomic stability — at least by the wretched standards of the first half of the 20th century. Moreover, the ability to hold diversified portfolios is far greater now. 

Such changes suggest the risk premium, often believed to be excessive, should have fallen.

The Credit Suisse study estimates aggregate real returns on stocks and bonds in 23 markets weighted by market capitalisation at the start of each year. It shows, interestingly, that the excess return of equities since 1970 have been very low and since 1990 negative. 

But this is because of very high real returns on bonds, as inflation and real interest rates collapsed. Looking ahead, it estimates the prospective excess return of equities at 3.3 percentage points. This is the same as the long-run historical average.


Estimates of Shiller’s metric do not exist for such lengthy periods for non-US stock markets. But estimates can be made since the early 2000s. 

The cyclically adjusted earnings yield is currently 7.6 per cent on the FTSE 100, 5.4 per cent on the DAX 30 and 4 per cent on the Nikkei 225. 

At current real interest rates on long-term bonds, the implied equity return premium is thus over 10 percentage points in the UK, over 7 percentage points in Germany and 4 percentage points in Japan and the US. 

The UK market looks extremely cheap today, perhaps because of the Brexit lunacy. Japan and the US look well valued, but not, by historical standards, overvalued.

Further support for the rationality of the US market today is that 55 per cent of the increase in the S&P 500’s market value over the past 12 months is due to gains in the information and technology sector. 

This makes sense, given US dominance in these areas and the technological shift of 2020. We should also note that real interest rates below zero make future profits more valuable than profits today, in terms of present value. 

Looking through the short-term impact of Covid-19 makes sense.


Given the interest rates, then, stock markets are not overvalued. The big questions are whether real interest rates will jump, and how soon.

Many believe that ultra-low real rates are the product of loose monetary policies over decades. Yet, if that were right, we would expect to see high inflation by now.

A better hypothesis is that there have been big structural shifts in global savings and investment. Indeed, Lukasz Rachel of the Bank of England and Lawrence Summers of Harvard argued in Brookings Papers 2019 that real economic forces have lowered the private sector’s neutral real interest rate by 7 percentage points since the 1970s.


Will these structural, decades-long trends towards ultra-low real interest rates reverse? 

The answer has to be that real interest rates are more likely to rise than fall still further. If so, long-term bonds will be a terrible investment. 

But it also depends on why real interest rates rise. If they were to do so as a product of higher investment and faster growth, strong corporate earnings might offset the impact of the higher real interest rates on stock prices. 

If, however, savings rates were to fall, perhaps because of ageing, there would be no such offset, and stock prices might become significantly overvalued.

Some major stock markets, notably the UK’s, do look cheap today. Even US stock prices look reasonable, valued against the returns on safer assets. So will the forces that have made real interest rates negative dissipate and, if so, how soon? 

These are the big questions. 

The answers will shape the future.

The world should be wary of ‘feeding crocodiles’ in China

Hong Kong protesters have watched their free international city be snuffed out

Finn Lau 

Pro-democracy protesters under fire from police water canons in Hong Kong in 2019. More than 10,000 protesters have been arrested and some have been given stiff jail terms © Isaac Lawrence/AFP/Getty


On August 11, the press reported that the Hong Kong government had issued a warrant for my arrest under the new national security law. 

I learnt of this in exile, where I’ve lived since January 2020.

Hong Kong, where I was born 27 years ago, is far more than a capitalist enclave in a communist country. It has been a haven for refugees from China, Vietnam and other lands of oppression. 

It is a city-state that adhered faithfully to the rule of law and is home to 7m multi-cultured, multi-ethnic, hard working and creative people.

Since the 1997 handover to the People’s Republic of China, Hongkongers have watched the Sino-British Joint Declaration, which obligated China to maintain Hong Kong’s autonomy for 50 years, being repeatedly contravened by the Chinese Communist party. 

The breach was complete with the enactment of the national security law last June 30.

Today’s CCP is not yesterday’s CCP. President Xi Jinping’s party does not believe it needs Hong Kong, because mainland China has become capitalistic, albeit in a state-run form. 

When the People’s Republic of China was established in 1949, the world’s markets were closed to the PRC. When Communist party leader Deng Xiaoping signed the Joint Declaration with Margaret Thatcher in 1984, only limited markets were open to China, so Hong Kong was still needed. 

But in 1999, the world’s most important market, the US, began trading with China with few restrictions. 

The rest of the world followed in 2001 when China joined the World Trade Organization.

Leaders of western democracies should note that their policy of “engagement” has enabled China to gain strength rapidly — it now has the world’s second-largest economy and one of the strongest militaries. 

International pressure hasn’t stopped the Communist party from increasing its repression of people in Xinjiang, Tibet and the rest of China. 

Power has enabled China to corrupt, coerce and menace individuals and institutions around the world.

This is what we have been confronting in Hong Kong. Frustrated by the failure of the 2014 Umbrella Movement to resist these encroachments, many Hongkongers born between the late 1980s and early 2000s adopted a political identity we called “localist”. 

Our slogans and strategies defined the pro-democracy protests of 2019 and 2020, culminating in almost 2m people marching peacefully in June 2019.

Localists were keen to experiment with different approaches to resistance, including leaderless “fluid-as-water” protests, and to try to leverage Hong Kong’s special trade status granted by the US to put pressure on the Chinese government to ease repression. 

As “Laam Chau” — an online persona I created at the start of the 2019 protest movement — my social media posts routinely reached hundreds of thousands of followers.

But localists have been targeted for harsh persecution. In Hong Kong, some of us are followed and beaten by both thugs and the police. 

More than 10,000 protesters have been arrested and some have been given stiff jail terms: six years for Edward Leung, four for Sin Ka-ho and seven for Lo Kin-man.

Contrary to misrepresentations by Communist party propaganda, localism is not racially based, nor exclusionary. We seek to protect Hong Kong’s local culture and identity, but we also seek to open Hong Kong to the world. Localists seek genuine autonomy within the rules-based international order.

The recently announced investment treaty between the EU and China is more than regrettable, because EU leaders have chosen, paraphrasing Winston Churchill, to continue to “feed the crocodile”.

Be aware that the situation has changed — the CCP crocodiles have grown. In Hong Kong, the life of a free international city is being snuffed out. 

That is what awaits any place that goes soft on the Communist party. 

Tyranny wins when resistance ceases.


The writer is an activist and founder of Hong Kong Liberty

Avoiding America’s Vicious COVID Cycle

The United States has the means not only to arrest current negative public-health and economic dynamics but also to transform them into a virtuous cycle. But this will require sustained and simultaneous efforts in four areas.

Mohamed A. El-Erian


LAGUNA BEACH – As excited as we all understandably are about the arrival of the first COVID-19 vaccines, the immediate road ahead remains treacherous. 

The United States, in particular, could be on the verge of a horrible scenario in which ongoing slippages in each of four areas – public health, the economy, policy, and household behavior – end up making those in the other areas even worse. 

Over the next few weeks, they risk setting in motion a vicious cycle that, if it materializes, could shatter the lives and livelihoods of many more people, even though vaccines are in sight.

Fortunately, through individual and collective action, the US has the means not only to arrest these dynamics but also to transform them into a virtuous cycle. This will require a set of sustained efforts rather than simple repetition of one-off measures.

Notwithstanding the restrictions that one state after another is putting in place, America’s current wave of COVID-19 hospitalizations and deaths is unlikely to subside in a lasting fashion. Yet, rather than regarding these measures as necessary but insufficient, too many Americans will instead be inclined to conclude – incorrectly – that restrictions are ineffective except in their very narrow role as temporary circuit breakers.

Moreover, the US is failing to get a handle on public-health challenges at a time when the economy is already weakening. The recent string of increases in weekly jobless claims confirms that the recovery in both the labor market and the overall economy is losing steam. More granular daily indicators of economic activity (such as mobility, restaurant bookings, and search activity) further support this view.

A growing number of economists now believe that the more comprehensive monthly jobs report for December, released in early January, may show negative job creation. It could be only a matter of time until we start worrying about the threat of a US double-dip recession similar to the one that Europe may already be experiencing.

The third area of concern is the overall US policy response to the economic crisis, which remains unbalanced and inadequate. Yes, monetary policy is still in “pedal to the metal” mode, with the US Federal Reserve expected to do even more at its December 15-16 policy meeting to support economic recovery. Unfortunately, the world’s most powerful central bank is essentially pushing on a string when it comes to long-term economic well-being.

Little of what the Fed does these days addresses the structural impediments to short and longer-term inclusive and sustainable economic growth. Meanwhile, its ample and predictable liquidity injections continue to decouple Wall Street from Main Street, worsen wealth inequality, and encourage excessive risk-taking that threatens future financial stability.

The policy response that can make a difference – a comprehensive fiscal package and pro-growth structural reforms – is nowhere to be seen. Any economic rescue measures that emerge from the painfully protracted negotiations in Congress will likely be too small, too narrowly designed, and insufficiently timely to stop the scarring that risks smothering the US economy’s dynamism.

This triple worry – public health, the economy, and economic policies – in turn fuels problematic household behavior. The US government’s inability to control yet another COVID-19 wave is certain to erode public trust further and undermine the adoption of guidance on healthy behavior. 

Increased restrictions inevitably add to the short-term economic pressures on many households and are likely to dampen consumer sentiment, robbing the economy of an important driver of growth. Delays in fiscal transfers compound the risks to US consumption and investment at a time when the global economy is in no position to take up the slack.

It is not hard to see how this combination of factors can trigger a negative feedback mechanism, with nearly every disappointment in any of the four areas making the other three more likely to disappoint even more. Economists call this an adverse multiple equilibrium, meaning that one bad set of outcomes makes it highly likely that the next outcomes will be worse. The good news is that this dynamic can be arrested and turned into a favorable multiple equilibrium.

Achieving this will require America to make simultaneous efforts in all four areas. For starters, the US needs better pool testing for the SARS-CoV-2 virus, timely tracing, and focused isolation of COVID-19 infections. The country also needs an economy that builds consumer and investor confidence while limiting its decoupling from frothy and increasingly speculative financial markets.

The third key element is a more balanced policy approach that supplements much-needed relief measures with steps to counter the mounting downward pressures on both supply and demand dynamics. These should include initiatives to modernize and expand infrastructure, increase skills acquisition in the labor force, counter uncompetitive firm concentration, improve safety nets, and enhance other efficient redistribution mechanisms. Finally, more responsible household behavior – in particular, strict adherence to social distancing, hand washing, and mask wearing – can help to limit COVID-19 transmission.

While counting down the days to widespread adoption of effective COVID-19 vaccines, we must not lose sight of the difficult journey still ahead. Without pronounced and sustained efforts now to turn a vicious cycle into a virtuous one, the US runs the material – and unnecessary – risk of many more deaths, and of a sluggish, partial, and insufficiently inclusive recovery.


Mohamed A. El-Erian, Chief Economic Adviser at Allianz, the corporate parent of PIMCO where he served as CEO and co-Chief Investment Officer, was Chairman of US President Barack Obama’s Global Development Council. He is President of Queens’ College, University of Cambridge, senior adviser at Gramercy, and Part-time Practice Professor at the Wharton School at the University of Pennsylvania. He previously served as CEO of the Harvard Management Company and Deputy Director at the International Monetary Fund. He was named one of Foreign Policy’s Top 100 Global Thinkers four years running. He is the author, most recently, of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse.