Some Encouraging Developments in the Economy

There's plenty of gloom out there if you're hungry for more. But I wanted to pass along a couple of developments this week that give me some hope.

First, via Rebecca Wilder and Arnold Kling, the Federal Reserve's H8 statistical release shows a big increase in real estate loans held by large commercial banks during the last week of September. There's likely a mechanical explanation in terms of some reallocation of security ownership during the recent turmoil. But if there has also been an increase of direct lending, that would be a promising development.

Real estate loans held by large commercial banks in billions of dollars. Source: Federal Reserve.

Whatever the meaning of those numbers, let me separately suggest that the recent dramatic drop in stock prices means that equities are more reasonably priced today than they have been at any time in the last decade. I am speaking from the perspective that the true value of a stock is the claim it represents on the discounted present value of future earnings. Stock prices have fallen much more than a reasonable projection of long-run earning potential, with many stocks offering a dividend yield today that is not far from the coupon yield on bonds. Once we get past the current economic challenges-- and we will-- those dividends are going to grow with inflation and real GDP, whereas coupons remain stagnant.

Capital Chronicle notes that Yale Professor Robert Shiller tries to capture the long-run value of stocks by taking the ratio of the current stock price to a ten-year average of recent earnings. On the basis of that long-run price-earnings ratio for the S&P500, you'd say that stocks today are a better buy than they've been at any time since 1995.

Granted, the economic picture is going to get worse-- perhaps much worse-- before it gets better. But the best time to buy stocks is 3 to 6 months before the recession is over. The last two recessions each lasted for 8 months. The current recession I believe began in December, which makes it 11 months old already. The longest postwar recessions on record lasted 16 months. This one could well go longer than that, but even if it does, this might not be a bad time to start buying.

Just sayin'.

Comments

[Smarty_Pants:]

"this might not be a bad time to start buying. Just sayin'."

Of course this time it IS different in that the government has changed the rules to "we're gonna do whatever we want and too bad if you get shafted as a result".

Until the dust truly settles, there's no hurry to buy. As long as Paulson and Bernanke are in panic mode short term risks are very high. WaMu stock was a great deal just before the FDIC turned it into an object d'art.

2008 Oct 16 10:14 AM

[cynic69:]

First of all everyone knows that common stocks have no real value in that when the co. goes broke the shareholders get nothing. Secondly the forward looking earnings for stocks is a stockbrokers silly dream, based primarily on how much he has to earn in commissions to make the payments on his girlfriend's downtown apartment. Anyway Jim I think you should go all in. Those cheap stocks are just waiting for someone to give them a new home.

2008 Oct 16 12:28 PM

[Urbane Gori...:]

Re: "let me separately suggest that the recent dramatic drop in stock prices means that equities are more reasonably priced today than they have been at any time in the last decade" ....

Yes. And when a patient dies in a hospital, the 'silver lining' is that a bed has just been freed up for the next ICU patient.

Someone just stole my half-full glass of water!

jegan ;-)

2008 Oct 16 03:37 PM

[Steven Hansen:]

you are keeping pretty close to the vest why you see the recession leveling off in mid 2009

2008 Oct 16 09:02 PM