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ANNOUNCER: Brought to you in part by ADM, feeding the world is thebiggest challenge of the new century, which is why ADM is conductingresearch into aquiculture and other new food sources. ADM,supermarket to the world. Additional funding is provided by the JohnM. Olin Foundation, the Lilly Endowment, the Lynde and Harry BradleyFoundation, and the Smith Richardson Foundation.
MR. WATTENBERG: Hello, I'm Ben Wattenberg. The rise in the stockmarket is becoming topic number one at the office water cooler. Whatwill the Dow do next, it's already touched 11,000. When will it hit15,000, 20,000, 30,000, or will it come tumbling down? Two oftoday's guests think the stock market is undervalued, wayundervalued. They argue in the forthcoming and provocative new bookthat the Dow Jones average and should be valued at 36,000 today. Theco-authors of Dow 36,000 are James Glassman, the DeWitt-WallaceReader's Digest chair at the American Enterprise Institute and afinancial columnist for the Washington Post, and Kevin Hassett,resident scholar at the American Enterprise Institute, and co-authorof the Magic Mountain, A Guide to Defining a Using a Budget Surplus. Glassman and Hassett's views do not to go unchallenged on thisprogram. They are joined by a skeptic, Robert Shiller of YaleUniversity, and author of Market Volatility. The topic before thehouse, Dow 36,000? This week on Think Tank.
MR. WATTENBERG: The stock market has soared to new heights at theend of the 1990s. Back in 1981, when Ronald Reagan took office, theDow Jones industrial average stood at around 800. When PresidentClinton took office in 1993, it hovered near 3,200. Now it's over10,000. This unprecedented rise in the market has prompted some toask is something different going on this time? To answer this andother questions we turn to our panel. Glassman and Hassett, I'lljust sort of use that as a one -- maybe we'll start with you, Jim. You are both known as devotees of the market, that you believe in theworkings of the market. And yet, and it occurred to me, as Iunderstand your thesis, you are saying that not only is the marketwrong now by pricing the Dow at 11,000, but it's been wrong fordecades, and it should be right now, the market, this all wonderfulthing that you guys worship, is making this phenomenal mistake insaying it should be three times higher. Why?
MR. GLASSMAN: Well, first of all, Ben, we have a lot of respectfor the markets, but it's quite possible that markets make mistakes. And they certainly have in the past. And what's happening now is,there's a process of learning that's been going on, that we thinkexplains what's happened in the last 20 years. Let me just give youone example of a mistake that markets learn from. Back in the 1950s,actually the '30s, '40s, into the late '50s, people believed thatstocks were just so risky that they demanded in a stock that it pay adividend that was higher than the rate on Treasury bonds. That'scompletely -- people would be baffled by that today, where interestrates -- where dividends are like 2 or 3 percent. In those days, thedividends from stock were higher than from Treasury bond. Well newinformation came out --
MR. WATTENBERG: And now, they're about a third or so, somethinglike that.
MR. GLASSMAN: Yes, now it's about a third. New information cameout, people learned that, gosh, you know, the truth is that stocksare not so risky that you need to demand that kind of a dividend. And starting in 1958 a shift occurred and that shift persists today,40 years later, stocks have consistently paid dividends lower thanthe dividends of Treasury bonds, which we now think is quite logicaltoday. That's the kind of paradigm shift that we think is going onright now with stocks in general.
MR. WATTENBERG: Kevin, you used to work as a senior economist atthe Federal Reserve Bank under Chairman Greenspan?
MR. HASSETT: That's right.
MR. WATTENBERG: You and Jim obviously believe what Jim just said,that a major paradigm shift is going on, at the same time, yourformer boss, Chairman Greenspan, give or take a few years and a fewsyllables, is talking that the market may be overpriced and isirrationally exuberant.
MR. HASSETT: That's right. We do not believe that the marketright now is plagued by over exuberance at all. I think theimportant thing to remember, and something that Jim and I recognizein our book and acknowledge over and over again when we speak aboutthis, is that the market is always a tension, there's always atension in the market between the argument for things going up andthe argument for things going down. And a rational investor shouldlook at the two arguments and decide which one he or she believes. And, you know, we set out to just identify the argument for up,because every argument we were seeing was the argument for down Andas we looked more and more at it, we found it reasonably convincing.
MR. WATTENBERG: Okay. We're going to come back in just a momenttoday to the --
MR. GLASSMAN: I'll tell you one thing about Greenspan, I mean,I'm a great admirer of Alan Greenspan's, I'm sure Kevin is an evengreater admirer. But, the truth this, from the time he made thatspeech, December 5, 1996, until the present day the Standard &Poor's 500 index has returned over 80 percent. So lots of people --
MR. WATTENBERG: You mean, it's gone up by 80 percent?
MR. HASSETT: It's gone up 80 percent.
MR. GLASSMAN: To it's gone up, including its dividends.
MR. WATTENBERG: All right. We're going to return to yourspecific theory as to why the Dow is going to triple. But, BobShiller, do you think the market is high now?
MR. SHILLER: Yes.
MR. WATTENBERG: Too high?
MR. SHILLER: Well, the Dow should probably be 6,000, if you'relooking for hard numbers. It would be different by a factor of about--
MR. WATTENBERG: So you're saying, give or take, it should be cutin half, and you're saying it should triple? Other than that, you'rein perfect agreement?
MR. SHILLER: Well, there's great uncertainty about all of this. And I really don't want to say that I know where the Dow should be. Absolutely not.
MR. WATTENBERG: Having just said it?
MR. SHILLER: Incidentally, I should correct that. I was sayingthat if historical attitudes toward risk persist, then it would bereasonable that the Dow would be at 6,000. But, I am in agreementwith you that has been historically underpriced. So it should be --
MR. HASSETT: And we agree with Bob that if people went back tobeing as fearful of stocks as they historically have been, then 6,000is probably a number of that you could get very, very easily.
MR. WATTENBERG: You wrote, Bob, in August of 1997 -- everybody inthis business has written something that's been wrong, I may as wellget it out early. You wrote in Intellectualcapital.com, an articleentitled 1929 Redux, that, 'we have a market that by many indicatorsis a more overvalued than at any time since that fateful summer.' Now, that was about two years ago and the market has gone up, what,50 percent since then?
MR. SHILLER: That's true, you won't disagree with that by theratios. It has never -- this is a historic moment, but you have tosit and reflect. We may have disagreement, but we agree on that.
MR. HASSETT: If the old ratios tell you what's going to happen,then he was right. And so it's time to rethink the old ratios orthat's going to happen.
MR. WATTENBERG: Now we come to the crux of this matter. Jim andKevin, you say the market is underpriced, tell us why?
MR. GLASSMAN: The standard measurement for whether the market isoverpriced or not are things like price-to-earnings ratios, anddividend yields. And the price-to-earnings ratios, how many dollarsdoes it cost, when you buy a stock, to buy a dollar's worth ofearnings of a company. And that's at a historic high, and dividendyields are at a historic low. But we believe, and there is a lot ofevidence, that these indicators really aren't telling us very muchanymore. And that they ought to be sort of pushed to the side. Youcan still look at them, but really it's much more significant to lookat other things. And what we think is going on is that people arebidding up the prices of stocks, because they understand, investorsunderstand what economists have known for a long time, which is thatstocks are an incredible deal, they are a really, really good deal. And that over the long-term, they are no more risky than, say, bonds. And if they are no more risky over the long-term, they ought toreturn about the same as bonds, which means that their prices oughtto go up. And that's really what's going on right now. We thinkit's a rational response to a circumstance that has prevailed for along time, but people are just waking up to it for a number ofreasons.
MR. WATTENBERG: But, it can't be a rational response if it's athird below what you think it ought to be. One of you, either themarket or you, are wrong.
MR. GLASSMAN: It's a process. Just as a Bob Shiller says, that,gee, the market ought to be at 6,000, he saying it ought to be. Heis also contradicting what's going on with the market. I don't thinkanybody believes, even the believers in efficient market theory, thatthe market is exactly properly priced every second.
MR. WATTENBERG: So the root of your theory is that bonds andstocks are equally risky?
MR. GLASSMAN: Right, and by the way that is not a controversialnotion. That over the long-term, the volatility, which is theextremes of the ups and downs, of stocks and bonds are roughly thesame. In fact, Jeremy Siegel (sp), distinguished professor atWharton, argues in his very important book Stocks for the Long Run,he says flatly in fact that stocks are less risky than bonds overlong periods of time. It's not a controversial notion.
MR. WATTENBERG: Is it not a controversial notion?
MR. SHILLER: Historically, you're right. Though with inflationmore stable, now I'm not sure that's still true. And because it'sthe inflation risk that creates the risk in bonds. And secondly, wehave index bonds now. And what strikes me, when looking at the levelof the market, is that you can now buy a U.S. Treasury 30-yearindexed bond, which is perfectly safe --
MR. WATTENBERG: Indexed for inflation?
MR. SHILLER: Indexed to inflation, so that means the real valueis guaranteed, and you can get 3.9 percent. You compare that withthe S&P, and the earnings yield on that is 2.8 percent. So itseems to me that we've got kind of like a negative equity premium.
MR. WATTENBERG: They have a reason, which Kevin will now -- heexplained it to me in the green room before. So that's the base, thebase is that they are not anymore risky and, therefore, what?
MR. HASSETT: Okay. Therefore, it ought to be the case thatstocks and bonds put about the same amount of cash in your pocketover time. If there were two types of bond and they had the samerisk characteristics, then they ought to be priced about the same,you ought to get about the same rate of return. Just, if you boughtan AT&T bond or an IBM bond, for example, then they are sort ofabout the same company in terms of how risky they are, what a greatblue-chip company they are, and they ought to give you about the sameamount of cash. And so, our calculation that yields to Dow 36,000,is just that. You know, what would have to happen to prices today,so that, from that point on, the returns on stocks and bonds ought tobe about the same. Now, there's some uncertainty about the exactlevel, but our assumptions I think are pretty darn cautious.
MR. WATTENBERG: Give me an example of what that means. Iunderstand that on the bonds side, in the other words, if I take$100, it's paying 6 percent, and so I'm going to get $6 a year, it'sa 20 year bond, I get $6 a year in the mail for the next 20 years. Now, how does that relate to the price of a given stock, that's whatI don't quite --
MR. HASSETT: Right. Well, the difference between the amount ofcash that a stock delivers and the amount of cash that a bonddelivers is very simple. The cash from the stock rose over time.
MR. WATTENBERG: It starts lower but grows.
MR. HASSETT: It starts lower and it gets higher. So if you put$100 in Exxon in 1977, you'd be getting a dividend back then of about$5 or $6. And relative to your initial stake, the dividend today isalmost $30.
MR. GLASSMAN: If you total up all the cash that, let's say, anExxon dividend has paid you over a 30-year period, and compared thatto what a bond would have paid you over that period, it would be likeabout four times as much. And we're talking about Exxon, which isnot a super growth stock. So that's too much money.
MR. WATTENBERG: So then the Exxon shares that were selling for$100 in 1978 should have really been selling, to be equal, shouldhave been selling at $400?
MR. GLASSMAN: Yes, although one of the things that we talk aboutin the book is that these circumstances today are quite differentfrom what they were in 1977.
MR. WATTENBERG: We are going to come to that.
MR. GLASSMAN: Right, so in '77, it might have been a time whenpeople's aversion to risk made a lot of sense. They were scared, itdoesn't make as much sense today.
MR. WATTENBERG: Bob, let me ask you, so far you've heard thisthesis, and I know you've heard it before. Some other experts havecalled it, stupid and insane, to use two -- that the authorsthemselves are promoting, they gave this out at a recent discussionthey were bragging that Mr. Brusca (sp), former chief economist ofNikko Securities said this was a stupid article, and that somebodyfrom the Australian Financial Review called it insane. Now, whatyou've heard so far, and is that either stupid or insane?
MR. SHILLER: The problem is that I don't your numbers reallysupport -- can you still change the title of the book? I mean, howabout Dow 15,000?
MR. WATTENBERG: You're saying it should be worth is 6,000?
MR. HASSETT: No, we can't change the title. But, we agree thatthere is uncertainty about the exact level.
MR. SHILLER: Let me give the calculations. Wait a minute, can Igive the calculation? It's very simple. Right now, index bonds,30-year index bonds are paying 3.9 percent. Okay. The S&Pindex, the stock market is paying 1.24 percent.
MR. WATTENBERG: That's the yield, the dividend yield of thoseshares.
MR. SHILLER: Right. And so, let's say 1.2 to 3.9, the differenceis 2.7 percent. So in order for that to be made up, you have toexpect 2.7 percent growth. But, historically it's only been, as yousay, only 2 percent. So it sounds like the S&P index, based onthis sort of calculation, will under perform the riskless bonds.
MR. GLASSMAN: Right. But, Bob, you know as well as I do, infact, all economists have been scratching their heads over theseindex bonds ever since they came out. These index bonds, which infact are a pretty good investment, I think your viewers should knowthat --
MR. HASSETT: And we treat them in the book, and tell people tobuy them, have their bond of their portfolio be in these things.
MR. GLASSMAN: Right, they are paying a terrific -- they are aterrific deal. Nobody expected that the real interest rate on thesebonds would be 3.8-3.9 percent.
MR. HASSETT: It's almost a percent higher than the real rate youwould get from looking at the non-indexed Treasury's and subtractingthe expected inflation that the CBO has in their forecast, forexample.
MR. GLASSMAN: So, they are an anomaly. These bonds are ananomaly, and I think that -- this is my guess, I don't know if Bobwould agree, I think over time people are going to understand what aterrific deal these bonds -- people don't even understand thesebonds. And, over time people going to realize, hey, they're a prettygood deal. And as a result those real rates will drop down. So Iwouldn't really get fixated on these bonds.
MR. HASSETT: That's another reason to invest in them now. And ifwe were to -- so Bob gave us the 15,000, if we use those bonds, andif we think that 3 percent instead of 3.9 is the right rate, thenit's going to --
MR. SHILLER: No, 15,000 was on the really high side. That's whatI hope to bargain you down to.
MR. WATTENBERG: But, wait a minute. This is not just a questionof bargaining. Your original view was not that it should be 15rather than to 36, but that it should these 6 rather than 11. Imean, we are not talking apples and applesauce here, we are talkingapples and elephants. They are saying, the world has changed, or aswe say, the earth has moved. Okay. And you are saying, no, ithasn't, I mean, same old, same old.
MR. SHILLER: Well, see, they could be right. I granted that atthe beginning. And the world does change, and it's a mistake toalways assume that history will repeat itself. But, that's onereason why we also have to expect that there is some risk to stocks. We don't know -- it's true that every 30-year period in stock markethistory, stocks have outperformed bonds.
MR. WATTENBERG: Every 20 years isn't it?
MR. SHILLER: Well, not quite 23, I don't think.
MR. HASSETT: It's very close on that.
MR. SHILLER: Close on 20. But, how many 30-year periods have wehad in stock market history, non-overlapping, you know, it's likefour -- it depends what you call it.
MR. WATTENBERG: But, suppose you overlapped them, then you'd have100 or more.
MR. SHILLER: They're not independent. The fundamental thing isthat the stock market is a residual claimant. If you own shares, youget money after everybody else is paid, and there are no guarantees. People know that. The government is not guaranteeing the stockmarket, the FDIC is not guaranteeing it. Nobody is guaranteeing it,and it's tough luck if you invest in stocks and it goes down.
MR. WATTENBERG: That's sounds very reasonable.
MR. GLASSMAN: Well, except that nobody is guaranteeing bondseither, except for these one kind of special bonds of which there islike $68 billion outstanding, which is not very much.
MR. WATTENBERG: Well, but they are guaranteed by corporate law,which says the bondholders get paid first.
MR. GLASSMAN: No, no. By guarantee, what I mean it is, there'sno protection against inflation.
MR. WATTENBERG: Well, there is a partial --
MR. GLASSMAN: No, there isn't. Let me just give you an example--
MR. WATTENBERG: There is no protection against inflation.
MR. SHILLER: And that protection isn't as valuable as you don'tmight think. So by the time the company is in the tank --
MR. GLASSMAN: For a corporation.
MR. SHILLER: -- but even being first in line at the tank isn't sogood.
MR. GLASSMAN: But, even treasury bonds, I'll just give you anexample, which is in Jeremy Siegel's book, that if you looked at theworst period for bonds over -- the worst 20-year period --overlapping 20-year period, so there are dozens -- there are 190 ofthem or something like that, 180 of them, you find that the worstperiod for bonds in real terms, that's after inflation is factoredout, is minus 3.1 percent. That's annually over a 20-year period,man, you really lost a lot of purchasing power. Whereas, the worstperiod for stocks, 20-year period for stocks, is plus 1 percent. So,to believe that bonds are not risky is to be making a huge mistake.
MR. WATTENBERG: Let me ask another question. There is all thistalk going along in the economic community about whether or not thereis a new paradigm, in other words, as we said in the setup piece, issomething different, is there something intrinsically different. Andif you go back, say, to the mid-1980s and say, what would one, two,three smart follows the say if I said, how would you improve theeconomy of America and the world, you'd say, well, we ought toderegulate, we ought to go to more trade, we ought to end the ColdWar, et cetera, et cetera. And the funny thing happened is, we didall those things, and what do you know, the economy, at least in theUnited States, is taking off just as if we had done all those things. Now, the question is, is what you're talking about, which is acontinued rise in the stock market, is that due to this sort ofarcane misreading of the market that you call the risk premium, or isit due to some titanic, major shift in the way people do business?
MR. GLASSMAN: Well, for reason -- one of the reasons that therisk premium is going down, in our view, the reason that people feelthat stocks are less risky than they thought they did, is because ofthese political and economic changes that you just described. Imean, the fact that, for example, very simply, the fact that we don'thave a Cold War and that there is, you know, not a nuclear threat --
MR. WATTENBERG: It's good stuff.
MR. GLASSMAN: Right. That makes people feel safer about theirlong-term investments. The fact that American corporations have donea very good job reorganizing themselves, that we have a bettermonetary regime, there are a lot of things. But, what we do notbelieve, and I want to make this very clear, because they're a bunchof books on the same subject, is we do not believe that stocks willrise to 36,000 because of some kind of fantastic new economy paradigmwhere the economy, instead of rising at a real rate of 2 or 2-1/2percent a year is going to suddenly jump to 3-1/2 or 4 percent. Idon't rule that out, but that's not part of our theory.
MR. HASSETT: That's an upside argument, too. So, I mean, if hegave us 4 percent of real GDP growth, which is what we've seen 3years in a row, I guess, then you'd get a number well, well above thenumber that --
MR. WATTENBERG: The stock market -- the value of the S&P hasgrown by 20 percent a year or more for the last 3 years; is theright?
MR. GLASSMAN: The last four years in a row, which has neverhappened before in the stock market.
MR. HASSETT: And it's looking like it's going to do it again.
MR. WATTENBERG: Bob Shiller, you are in the role of the skeptichere, is that just an anomaly, or are these guys up to something? Imean, four years is four years. That's not chicken soup or choppedliver.
MR. SHILLER: No. It's quite a remarkable phenomenon,unanticipated by just about anybody. But, the issue is whether animportant part of it, as you argue, is that people have learnedsomething, learned that stocks are not risky, or is it somethingelse. And there's a number of other psychological theories that haveadded in to this. One of them is that they've seen the market go upfor so long, many times, that they just think that it can only go up. That's one theory. There are other --
MR. HASSETT: Can I respond to that, because I think that one ofthe big motivations for us, as we worked through this book, was thework that Bob and some of his colleagues have done in this area,because we think that the work identifying the mistakes that peoplehave made in the past in the market, that they were too fearful aboutstocks, too prone to sell the first time they went down, and so on. We think that that work has diffused out to financial professionalswho are acting kind of like psychologists. They are helping peoplethrough their neurosis toward stocks. And teaching them how tobehave correctly, and that's one of the reasons why we think thissort of learning process is going on.
MR. WATTENBERG: Also, you were pointing out that the number ofinvestors and the kinds of investments, the 401(k)s and things likethat, play into your scenario. I mean, as more people --
MR. HASSETT: That's right, so there are more and more peopleputting their money in the market, they are locking it up for thelong-term, so that these long-term statistics about riskiness mightbe more relevant. So we think that those forces drive stocks tohigher prices. But, I think the fundamental question is, you know,three or four years from now will the PE have gone back to 20 or not? If the PE --
MR. WATTENBERG: PE means the price-to-earnings ratio?
MR. HASSETT: The price-to-earnings ratio.
MR. WATTENBERG: A multiple which is about 30 now, or something,will it go back to 20?
MR. HASSETT: That's right. Or is it going to go up to 40 or 50,or even above, or stay where it is. I mean, those are the threepossibilities. But, we think if it goes up again, and it continuesto increase at the rate that we've seen in the last few years, thenthe story is going to have to be our story. It's the only one thatmakes sense.
MR. WATTENBERG: Your colleague Herbert Stein says that a trendthat cannot continue, will not. So, I mean, on you're not saying thePE is going to go up to 100 or 1,000.
MR. GLASSMAN: No, Ben, I mean we believe that when stocks reachwhat we call their perfectly reasonable price, or PRP, that indeedthey will level off, because they've gotten to the point where theamount of cash that goes into your pockets will be the same as bonds.
MR. HASSETT: And just where is that price, that's the question.
MR. SHILLER: You say PRP, that's new. I thought it was PHP,permanently high plateau -- which was Irving Fisher --
MR. WATTENBERG: That's 1929.
MR. SHILLER: It's really interesting that Irving Fisher in 1929said, there is a new era. He said that the price --
MR. WATTENBERG: He was right, this was a new era, it was calledthe Depression.
MR. HASSETT: But, you know what, if you listen to Bob and JohnCampbell when they wrote their very bearish article that they gave atthe Federal Reserve a few years ago, and shorted the market, theinstant you saw the paper, you would've lost more money than thepeople listen to Irving. So, this is very strange.
MR. SHILLER: Incidentally, I was still in the market.
MR. GLASSMAN: And Bob brings up an important point, which wetalked about in the book, we talk about Irving Fisher in the book. One of the problems with Irving Fisher was he went way overboard. Imean, he put every dime he could find in the market.
MR. HASSETT: He mortgaged his house and put the money in themarket.
MR. GLASSMAN: To prove that he was right. But, you know, thetruth is over the long-term -- I mean, if Irving Fisher himselfhadn't mortgaged everything to put it in the market, he was right. Imean, the fact is, if you had bought and held, even if you bought atthe worst possible time, just before the depression, and held on forlong time, you would have done extremely well.
MR. SHILLER: Until 1954, around that. It would have to be a longtime before --
MR. WATTENBERG: Thank you, Jim Glassman and Kevin Hassett and BobShiller. And thank you. We encourage feedback from our viewers viaemail. For Think Tank I'm Ben Wattenberg.
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