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No. of Recommendations: 23
http://turnkeyanalyst.com/2013/11/05/buffets-market-timing-s...

First, you gotta read Warren Buffett’s classic piece from 1999:

http://money.cnn.com/magazines/fortune/fortune_archive/1999/...

Buffett highlights the inextricable tie between GDP growth and corporate profits. GDP growth is the limiting factor (interest rates and margins are the other factors).

And here is his follow up in 2001:

http://money.cnn.com/magazines/fortune/fortune_archive/2001/...

Recently, there have been a spat of articles related to macro valuation signals and the stock market. Many of these articles talk about “Buffet’s favorite valuation tool.”

An example:

http://www.streetauthority.com/value-investing/one-buffetts-...

Why is Market Cap / GNP considered Buffett’s favorite? He said so…

“…probably the best single measure of where valuations stand at any given moment.”

–Warren E. Buffett from 2001 Fortune article

Gurufocus has a great article on the topic and some associated tools:

http://www.gurufocus.com/stock-market-valuations.php

Below is a chart of the Market Cap to GNP ratio since 1952 along with associated 5-year rolling percentile bands to indicate times of “excess.”

We are able to extend the ratio past the Wilshire 5000 data via CRSP, and you can also recreate a proxy via market-cap breakpoint data from Ken French’s website: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_....

Data on GNP/GDP only goes back to 1947 so we can’t do better than that.

Currently, the ratio stands at 1.224x.

Key takeaways?

Expensive, but not unprecedented.
Broke the rolling 5-year 95 percentile breakpoint.
Mean reversion to long-term mean of .70 would imply SERIOUS market drawdowns.

But what are the alternatives? 2.5% 10-year treasuries?
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No. of Recommendations: 3
I keep hearing how expensive the market is. It makes me nervous. But then I look at what I own and the fear passes. It seems to me we're returning to a world where many "new age" companies are being valued on a multiple of sales basis instead of a multiple of earnings basis. Just because the general market is overpriced doesn't mean that you can't find a nice basket of value out there.

I've had a similar situation recently in a real estate deal. I'm involved in a piece of property that has appreciated an average of 11% per year over the last 45 years. (Great location.) But if you were to ask someone what rate the property will appreciate at in the future, they would probably answer "somewhere around the inflation rate." But the price of a car or the price of medicine has almost nothing to do with the price of this property.

So, just because the market has gotten pricey doesn't mean it's time to be scared.
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But what are the alternatives? 2.5% 10-year treasuries?

I don't suggest that all of the following approaches are equally valid or acceptable, but as far as I can tell your options boil down to:

- Pile up cash till you see things really compellingly cheap. Might be a long wait, might not.
- Try your hand at market timing. (the first point is pricing, not timing).
- Try to beat the broad index with judicious security selection, based on diligent analysis.
- Try to beat the broad index with judicious security selection, based on quant criteria.
- Bet actively against the broad market, either as a hedge or as a profit-making trade in itself.
- Invest in equities in countries less overvalued than the US.
- Invest in things other than stocks, bonds, and cash. Not a lot of obvious choices.
- Live with low returns.
- Give away or spend all your money. Poor people don't have these problems.

Jim
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just something to think about

many companies now a days have their a good deal of their profit/rev from outside of the US.

now if you want to compare apple to apples you should also include part of the GDP/GNP of countries other than US to arrive at your ratio


or you can look at it like this. lets say all the companies in the US make their money outside of the US (all their profit and rev). would using the GDP/GNP of the US make sense? this is just to illustrate the issue here.

hy
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many companies now a days have their a good deal of their profit/rev from outside of the US.
now if you want to compare apple to apples you should also include part
of the GDP/GNP of countries other than US to arrive at your ratio
or you can look at it like this. lets say all the companies in the US
make their money outside of the US (all their profit and rev).
would using the GDP/GNP of the US make sense? this is just to illustrate the issue here.


This is a very valid issue, and a good reason not to take market cap to GDP ratio too seriously.
It's right, just not precise. It's just one quick and dirty way of
demonstrating an irrefutable truth that valuations seem to be very high these days.

If you're interested in adjusting the market cap to GDP ratio, net US receipts from
outside the US have risen from 5% of total corporate profits in 1960 to about 20% these days.
The percentage tends to spike higher for a while during US recessions
but has otherwise been a pretty smooth trend since then.
It hit around 37% briefly around 2009 as US corporate profits crashed,
but then that spike unwound again. Absent the recession spikes, it's pretty steady.
So, adjust the market cap part of the cap-to-gdp ratio down by about 0.27%/year.

The other big hole is that the fraction of domestic economic activity
taking place within listed companies varies over time.
I don't have a handy adjustment number for that.

In fact I suspect that if you wanted an equally simple two-number metric
that was actually better (more predictive, values more comparable across
longer time frames) you'd do better with aggregate market price/sales.
Even better would be median price/sales ratio of the S&P 500 companies,
since a few gigantic outliers with very high margins can throw things off.
Exxon, Apple, that kind of thing.

The "usual" better metrics here
http://www.smithers.co.uk/page.php?id=34
CAPE has the advantage of comparing the earnings of a set of companies to the market
value of that same set of companies, without the messiness of having
to figure out adjustments for exports, imports, private companies, and so on.


Jim
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If you're interested in adjusting the market cap to GDP ratio, net US receipts from
outside the US have risen from 5% of total corporate profits in 1960 to about 20% these days.


Agreed that it's not much of a metric, but if you wanted to fix it, your point makes sense, i.e. that you would want to consider US companies' activities outside the US. But surely part of that secular change is not just international success of US companies, but also the internationalization of business, what with free trade, consolidation, decline in shipping costs, etc. I don't know where you would get the numbers, but isn't it also plausible that non-US companies account for a greater proportion of sales within the US?

For instance, when a Canadian company gets the contract to build healthcare.gov, or a Brazilian company sells a lot of medium-sized jets to the US market, or an Israeli company becomes the #1 generic drug maker in the US?

If so, this would mean that the effect of foreign revenues to US companies would be at least partially cancelled out by domestic revenues going to foreign companies, and our rough indicator of US-company-market-cap:US-GDP might retain most of its usefulness.

Regards, DTM
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No. of Recommendations: 2
If so, this would mean that the effect of foreign revenues to US companies would be at least partially cancelled out by domestic revenues going to foreign companies, and our rough indicator of US-company-market-cap:US-GDP might retain most of its usefulness.

You're more optimistic than I.
When there are multiple factors not accounted for in a model, it's better
to fix them all one by one rather than hope that they cancel out properly.
Gosh that's a lot of work for anything starting with GDP.
Better to start with something that makes more sense.

I find variations of CAPE (extrapolated trend earnings) much more compelling, on the simpler foundation that
- the value of a given set of companies is a function of the future
earnings of those companies and nothing else
- if the collection is broad enough, the past trajectory of their
aggregate earnings is stiff enough that it can be extrapolated
- the extrapolation is of a slope with error bars small enough to
make the exercise pretty darned useful, even if it isn't perfect.

Interestingly, I was just looking at a chart of the median price/sales of the S&P 500.
This is a mix of valuation levels and the current position in the cycle of net margins.
Eyeballing it,
- You'll probably do pretty darned well if it's 1.2x or less
Since 1997 it's been below that only during the credit crunch.
- Things are getting choppy edging towards dangerous above 1.5-1.6x
- The current number is somewhere in the vicinity of 1.9x

Because this is a very breadth oriented approach, it says a lot more
about the *typical* company's than about any cap-weighted index.
Since we're value investors with concentrated portfolios hunting for
bargains (right?), that's of more interest than the value of the S&P 500.
If you look at the three periods of very high valuation of recent decades,
(1999ish, 2007ish, and recently), each has had a higher typical valuation that the last.
Median price/sales is *very* much higher now than at any time in the
tech bubble because the crazy valuations were concentrated then mostly
among only a relatively small number of very large TMT firms.

Jim
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No. of Recommendations: 1
When there are multiple factors not accounted for in a model, it's better
to fix them all one by one rather than hope that they cancel out properly.
Gosh that's a lot of work for anything starting with GDP.
Better to start with something that makes more sense.


No doubt. As I said, it's not much of a metric. I'm just saying that when the currently high level of this particular metric (US companies' market cap to US GDP) is used in support of the view that shares are pricey, one often hears the counterargument that you have to consider the expansion of the overseas revenues and profits that are obtained by US companies. It occurred to me, and I have never seen this pointed out, that you could perfectly well say the same thing about European companies and THEIR overseas sales and profits or about companies from just about any region. But the world market really is a zero-sum game, at least in any given year, and higher market share of US companies overseas may go hand in hand with lower market share of US companies in their domestic market. In other words, while Coca-Cola is doing well in Europe and Japan, VW and Toyota are also doing quite well in the USA.


Median price/sales is *very* much higher now than at any time in the
tech bubble because the crazy valuations were concentrated then mostly
among only a relatively small number of very large TMT firms.


Interesting observation. Do you have any numbers on that last one? I would have guessed the we were almost at 1999 levels of overvaluation, but I wouldn't have guessed that we were higher.

Regards, DTM
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Here's another mention of the same phenomenon, a broadly based over valuation :

While the valuation of the S&P 500 Index itself was higher in 2000, it’s notable that the overvaluation of the S&P 500 was skewed in 2000 by extreme overvaluation in very large-capitalization stocks, while smaller capitalization stocks were much more reasonably valued. In contrast, we have never in history observed the median stock as overvalued as we observe presently. Indeed, the median price/revenue ratio of stocks in the S&P 500 now exceeds the 2000 peak. Likewise, as Damien Cleusix has observed, if we examine valuations by quartiles (25% of stocks in each bin), the average price/revenue ratio of the two middle quartiles also exceeds the 2000 extreme.


(Hussman's most recent post)

Regards, DTM
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No. of Recommendations: 48
Median price/sales is *very* much higher now than at any time in the
tech bubble because the crazy valuations were concentrated then mostly
among only a relatively small number of very large TMT firms.
...
Interesting observation. Do you have any numbers on that last one?
I would have guessed the we were almost at 1999 levels of overvaluation, but I wouldn't have guessed that we were higher.


As it turns out, only this week did somebody teach me how to get this
out of the research database I use. So I now have the ability to
calculate median S&P 500 price/sales daily back to 1986.

There are various different data sources, so I get very slightly
different figures depending on which source I use.
There is a discontinuity in sources in 1997, for example.
The following figures are based on the average of the three sources.
The divergence is about .12 between the two sources 1997-2004, they agree well since then.
e.g., one source says the average day in 1998 was P/S of 1.487x, the other 1.331x.

Still, the general trend is pretty clear. I have no reason to believe
the figures are off by more than 10%, and if there is an error that
big then it's probably smooth and lasts several years.

The key observation is that S&P median price/sales almost never got above 1.5x 1986-2003 inclusive.
These are the only exceptions:
- There was a stretch in June-July 1999 that averaged 1.527x and peaked at 1.555x.
- Rather surprisingly there was another brief stretch end Jan to mid March 2001.
Average during that stretch was 1.513x and peak was 1.556x.
- Another very short stretch just after that, late May 2001, peak 1.550x.
Those three stretches account for ALL of the times 1986-2003 that
median S&P price/sales got above 1.5x.

It was then almost continuously above 1.5x from Christmas 2003 till early December 2006, but the peak wasn't that much higher.
Average in that stretch 1.564x, 95th percentile 1.647x, peak 1.7x.
Then it was continuously above 1.5x and periodically above 1.7x until early January 2008, then down below 1.5x again.
This entire stretch might indicate that the immense liquidity during
the credit boom lifted a very large fraction of the big boats.

The median P/S rolled over and got pretty low during the crunch, absolute bottom 0.69x.
The low probably wasn't really quite that low: by the time valuations got that low,
sales had probably fallen off a lot but not yet showed up in the reported figures.

But it wasn't that long before "typical" firms were once more getting
overvalued based on the recent liquidity glut.

A brief blip above 1.5x in April 2010, which I'd call the danger level.

Another long stretch above 1.5x, even above 1.7x for a while Oct 2010 through Aug 2011, then down below 1.5x again.
The average in the year ending July 2012 was about 1.475x, just below the danger level.

Then, this year's exuberant rally.
It has been above 1.7x almost continually since mid Feb this year,
and surpassed 1.9x for the first time Oct 25 and has stayed there.
Today's value is 60% above the average since 1986 (includes some iffy figures),
and 32-42% above the average since 1997.
In general, the market has been very richly valued since 1997, so that's quite something.

Looked at in terms of the three big valuation waves of recent years
- The highest one-year average of the median S&P 500 P/S in the tech bubble was the year to 2001-08-06 at 1.421x.
- The highest one-year average of the median S&P 500 P/S in the credit bubble was the year to 2007-10-25 at 1.689x.
- The one-year average today is 1.734x, and today's figure 1.921x.


However, remember two things:
(1)
This is the MEDIAN of the S&P 500 price/sales figures.
If the valuation of the few really giant companies is much higher or
much lower then this isn't saying much at all about the S&P 500 index.
That's why the 1999 peak was so apparently low. The broad cap weighted
market really was much more overvalued in 1999 than this figure suggests
because of the extraordinary overvaluation among some large caps.
However median P/S is probably a pretty good metric of how hard it
is to find a good deal among the typical US large cap universe.

In 1999 it was easy for a value investor to find good deals. Now, no.

(2)
This is price/sales, not price/value.
Sales figures are being used here as a proxy for longer term value based
on the notion that net margins are mostly mean reverting over longer cycles.
Historically that has been true, reliable, and very handy.
Alas, they have been going up for quite a while now, so it means you
have to decide what you think about the current long cycle of rising margins.

Specifically, the record breaking recent figures for median price/sales are some unknowable mix of
(a) substantial overvaluation of the typical large US firm right now, and
(b) it's different this time: the unusually good net margins (and
unusually high corporate profit share of GDP) are going to last a long time.
Rather surprisingly, I don't dismiss (b). Capital is winning over labour world
wide and that might last quite a while. But I think it's more than half due to (a).

Here are the year by year averages.
I don't claim these figures are perfect, but it gives you an idea.
Each P/S figure shown is the daily average through the year of each day's median price/sales among S&P 500 companies.
Period    P/S
1986 0.717
1987 0.843
1988 0.762
1989 0.818
1990 0.740
1991 0.738
1992 0.800
1993 0.908
1994 0.949
1995 1.020
1996 1.120
1997 1.269
1998 1.339
1999 1.388
2000 1.327
2001 1.386
2002 1.287
2003 1.277
2004 1.541
2005 1.568
2006 1.596
2007 1.668
2008 1.263
2009 1.058
2010 1.440
2011 1.554
2012 1.537
2013 1.760 (year to date)
Latest 1.921 (Nov 7)


Jim
(short the S&P)
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No. of Recommendations: 1
Since 2007 two viable alternatives for return have been removed: Bonds and real estate. Before 2008 many people put money into their house, purchased the biggest house they could afford. High single digit bond returns were not uncommon. It was OK to be leary of equities.

One thing that scares me is the margin in use today. But I imagine this is partly a function of low rates there also.
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In my view, as this year has progressed, more and more indicators of things being very overvalued are showing up.

Thanks to Mungo for that wonderful post on P/S.

I just read this piece called "The Fundamental of Market Tops":

http://www.ritholtz.com/blog/2006/03/the-fundamentals-of-mar...

It was originally written in 2004 and Mr. Ritholtz repost it in his blog in 2006. There is small reference to Mr. Buffett. I think it is not difficult to see a lot of similarities between points described in the article and the current environment.

Look at this comment at the bottom that a fellow wrote in response to the article back in March 2006:

Those are fine flags for detecting the top of a great raging bull market. Unfortunately, those sort of markets only come along once every 30-40 years, and we’ve just finished one a few years ago.

Pretty scary, isn't it?


Regards!

PS. One thing that makes me feel good since a couple weeks ago is knowing that our dear friend Jan has sold her TSLA shares. :)
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OK, that's exactly what I was looking for. Like you, I am short the S&P (via futures) and the broad nature of the current overvaluation makes shorting the index arguably more sensible now than it might have been in 1999, when shorting just the bad part (tech) maybe made more sense.

Like you, I prefer the 'substantial overvaluation' hypothesis, over the 'it's different this time hypothesis'; otherwise, it wouldn't make much sense to be short. And I am indeed a bit surprised that you give some credence to the 'it's different' explanation, and in particular attributing this to lower labour costs. I would be curious to know if you thought that sustainably lower energy costs, for example, would have the same effect.

The other major factor that might be invoked is that almost all countries currently have unsustainably low tax rates, or unsustainably high government spending rates, depending on which way you prefer to see this. This can go on longer than I can remain solvent with a short position, of course, but as Herbert Stein said, ...

Regards, DTM
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(short the S&P)

Jim - Have you bought SPY puts also?
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Jim - Have you bought SPY puts also?

Yup.
I always keep a few kicking around. I tend to buy a few when VIX is low and prices are at a fresh recent high.
They lose money almost all the time for me, and on average over time, so in that sense they're irrational.
But when they pay off, it's usually a really good time to have a little windfall and go shopping.
If you count the returns on the cash they provide to be deployed at those times, they're not so bad.
I remember my September 2008 puts very fondly...my best month ever.

But the puts position is far from what would be required to balance my long exposure.
My bigger hedge these days is short S&P futures.
I may switch some of that to short various sector ETFs, as not everything is equally overvalued these days.

Jim
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@RandomDoc

Are you the author of this turnkeyanalyst blog?

I noticed that the author is on the faculty at LeBow, and it just so happens that I recently began an MBA at LeBow. If so, what classes do you teach? I'd love to take a class taught by a fellow Fool.

Thanks!
-John
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No. of Recommendations: 21
Like you, I prefer the 'substantial overvaluation' hypothesis, over the
'it's different this time hypothesis'; otherwise, it wouldn't make much
sense to be short. And I am indeed a bit surprised that you give some
credence to the 'it's different' explanation, and in particular
attributing this to lower labour costs.


From one only-slightly-simplistic point of view, the number of workers
participating in the world economy has doubled in the last 15 years.
A lot of the new entrants don't demand very high pay to get out of bed in the morning.
Combined with enough technology and transport infrastructure to allow
them to compete with one another, the global labour situation is a buyer's market.
If the minions have no bargaining power, there's no reason to pay people much,
so payroll as a fraction of revenue falls and profits go up.
That labour glut may take a while to work its way through the python.
When the economies in which those workers life get rich enough and
labour is again scarce enough things will presumably swing back the other way.
But that could take a surprisingly long time.
Average US net margins might well stay at record breaking levels for a decade or two,
subject of course to the oscillations of the business cycle.

Thus, the high net profit margins and high profits as a share of GDP
might last a long time too. I think it will normalize eventually,
but "eventually" may be a whole lot longer than a business cycle so
a realist might have to consider this the new normal for a while.
I believe things will mean revert, but I don't have very high faith that it will be quick.
In the long run sense, I believe that my estimates of the market's overvaluation are correct.
Real total return will be lower than average until the valuation levels
across a cycle are close to their very long run norms.
But if that's 25 years from now, in another very different sense which
I don't normally consider, broad US equities might be somewhat attractively priced.
They are better than the other easy-to-buy alternatives, for now.
If "for now" means a year or three, then they are dangerously overpriced.
If "for now" means 25 years, it's a more nuanced discussion.

This is in combination with the other thing that I think will last
a surprisingly long time: the global savings glut.
Interest rates might not be low in the western world for the next 2 years,
but for the next 15 years. We may be in a low-nominal-return world for a very long while.

Jim
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That labour glut may take a while to work its way through the python.
When the economies in which those workers life get rich enough and
labour is again scarce enough things will presumably swing back the other way.
But that could take a surprisingly long time.
Average US net margins might well stay at record breaking levels for a decade or two,
subject of course to the oscillations of the business cycle.



In the general economy, labour is the most important cost of doing business, and unquestionably, if a company can reduce a major cost of doing business, and maintain its sales, it will be more profitable, and if it can do this sustainably, it is worth more. It is not so obvious to me that the same logic applies to a whole industry or to the whole economy. Other companies also have lower labour costs, and if competitive markets are working properly, standard theory is that excess profit margins will be competed away until they are close to the cost of capital. So mean reversion should not require a reversion to the previous cost of labour.

If we took another example, fuel costs are a hugely important cost to the airline industry, and a company that can find a way to reduce its fuel costs stands to become more profitable. But I would not expect that the economics of the airline industry would be fundamentally changed by a drop in fuel prices. There might be a few years of higher profits, as companies drag their feet about dropping prices to reflect their new cost structure, but I would expect the fundamental (lousy) nature of the industry to remain.

So it seems like a 'this time it's different' hypothesis requires not just enduring low expenses,, but also for something to be wrong with competition.

Regards, DTM
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So it seems like a 'this time it's different' hypothesis requires not just enduring low expenses, but also for something to be wrong with competition.

Good point. I certainly don't have a snappy comeback that makes it all make sense.

Won't stop me from trying, of course.
How's this for a possible narrative:
This (stagnant median real wages) is a rich world phenomenon only.
Since labour has become not only more plentiful but much more competitive
on a global scale, one would expect equalization as workers in disparate
places seriously compete with one another for the first time.
That leads to higher wages for those in poor places that were previously unable to get work that had a high value added, and lower
wages for those in rich countries who have been overpaid until now
because their jobs couldn't be done by people elsewhere.
The average guy in Guangdong is doing much better, the average guy in Michigan less so.

Looked at in a similar way:
The anomaly isn't that American blue collar workers can't get highly paid jobs any more.
The anomaly is the once-in-a-universe 50 year period that they could.
Tightening screws simply isn't worth $50k a year and never was.
Since so many of the low end white collar jobs are no longer plentiful, like bank
tellers and travel agents, the blue collar effect becomes even more visible in the stats.

Jim
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So it seems like a 'this time it's different' hypothesis requires not just enduring low expenses, but also for something to be wrong with competition.
======
Good point. I certainly don't have a snappy comeback that makes it all make sense.
======
Won't stop me from trying, of course.
How's this for a possible narrative:
This (stagnant median real wages) is a rich world phenomenon only.
Since labour has become not only more plentiful but much more competitive
on a global scale, one would expect equalization as workers in disparate
places seriously compete with one another for the first time.


I think this is exactly what has happened. But my problem isn't with the idea that labour costs have gone down - I think this is logical, well established, and I think it is likely to last a long time. And it's not just because of internationalization of the labour market and outsourcing, it's technological developments that allow you to build lots of things with less labour, cars for instance.

But if all or most companies have these new low labour costs, should we really expect them to all be more profitable? That is my basic question.

I use the example of fuel costs in the airline industry as a parallel situation where the predominant cost of doing business might go down, without making airlines more profitable in general. Another example might be utilities, for whom methane is often more than half of the cost of doing business. With current NG prices so low, they should be able to rake in the profits, if they could only charge the same thing for electricity. But they can't because competition between them (and also, in this case, regulators) force them to lower their costs to the points where profits are about the same, as one would hope and expect.

So my basic question is, why would this not also apply to labour? If everyone gets cheaper labour, and starts showing higher profits, shouldn't these juicy profit margins entice new entrants, with competition driving down costs and profit margins approaching the cost of capital? This is how our market-based system is supposed to work, and it seems to me that, to believe that sustainably higher profit margins will be possible because of lower labour costs, you have to invoke not just lower labour costs (which I acknowledge) but also some sort of new dysfunction in capital markets (which is possible, but for which I have not heard a convincing argument.)

Regards, DTM
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it seems to me that, to believe that sustainably higher profit margins will be possible because of lower labour costs, you have to invoke not just lower labour costs (which I acknowledge) but also some sort of new dysfunction in capital markets (which is possible, but for which I have not heard a convincing argument.)

There's an argument based on accelerating technological change, which might be viewed as permanent. The gist of it is this: there's so much opportunity for completely new businesses, that there's less reason for an entrepreneur to compete within established markets, leaving those old markets with relatively little competition.

To buy this argument, you'd also have to say why the corporate share of GDP jumped all of a sudden around year 2000: http://economistsview.typepad.com/.a/6a00d83451b33869e2017ee...
Maybe the internet enabled a burst of new markets?

But I still don't know if I believe it's different this time. Labor doesn't just compete with itself on price, it also competes with capital by voting. In the U.S. anyway, we've already seen hikes in gains taxes and passing of a health care act, things that capital presumably didn't want. Maybe the political environment is already shifting here (please, no replies on whether this would be good or bad!). If so, corporate margins might be reduced by increased taxes and the like.
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<<There's an argument based on accelerating technological change, which might be viewed as permanent. The gist of it is this: there's so much opportunity for completely new businesses, that there's less reason for an entrepreneur to compete within established markets, leaving those old markets with relatively little competition.>>

The information age is bigger than the industrial revolution. We are entering a period where labor, capital and know-how are coming together like never before. (Imagine a petri dish full of medium where a new bacteria gets introduced.) On the other hand, it could be 1929 all over again.
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I think you have hit the nail on the head : there is an interesting recent paper that makes this same exact point with some interesting analysis at http://www.eclac.org/noticias/paginas/3/35143/w15404.pdf? .
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This is in combination with the other thing that I think will last
a surprisingly long time: the global savings glut.
Interest rates might not be low in the western world for the next 2 years,
but for the next 15 years. We may be in a low-nominal-return world for a very long while.


I would appreciate very much if you could expand on this. What makes you think it will/could be as long as 15 years?

I don't believe the large increase in money supply over the last several years will necessarily lead to high inflation, but if velocity picks up it certainly could. Also, the longer we go with negative real interest rates the more likely it gets that we will see a severe dislocation. I feel I can make a decent argument either way, but since the consensus seems to be for higher inflation in the medium term (maybe reason enough to feel otherwise!) I would like to better understand the low rate case.
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I would appreciate very much if you could expand on this. What makes you think it will/could be as long as 15 years?

1. Why not? It's dangerous to make any strong predivtion.
2. Because I see it as an inevitable consequence of the global savings
glut, so it will last just as long. I can't thing of any good reason
to believe that it will end any time soon.

I don't believe the large increase in money supply over the last several years will
necessarily lead to high inflation, but if velocity picks up it certainly could

Do bear in mind that there has been no increase in the money supply at
all, only in the balance sheets of central banks.
The US broad (divisia) money supply is smaller than it was five years ago.
So, as you say, it's the multiplier that's key.
Until private banks create a whole lot of money there won't be any
chance of achieving the desired inflation.
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If everyone gets cheaper labour, and starts showing higher profits, shouldn't these juicy profit margins entice new entrants, with competition driving down costs and profit margins approaching the cost of capital? This is how our market-based system is supposed to work, and it seems to me that, to believe that sustainably higher profit margins will be possible because of lower labour costs, you have to invoke not just lower labour costs (which I acknowledge) but also some sort of new dysfunction in capital markets (which is possible, but for which I have not heard a convincing argument.)

This argument seems very plausible especially when one considers the much greater price transparency that exists today for virtually all goods and services in which a free market exists. This would seem to support the idea that lower labor costs will primarily benefit consumers rather than business in the long run. Other factors are obviously involved at the micro level - primarily the question of whether a company has a differentiated product offering that makes consumers less price sensitive.

This is, of course, pretty basic "Porter five forces" analysis with the lower cost of labor simply reflecting a diminishing of the bargaining power of suppliers - employees supplying labor as an input into the cost of production.
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Won't stop me from trying, of course.
How's this for a possible narrative:
This (stagnant median real wages) is a rich world phenomenon only.
Since labour has become not only more plentiful but much more competitive
on a global scale, one would expect equalization as workers in disparate
places seriously compete with one another for the first time.


There's other factors at work here as well.
There are a lot of extremely highly paid white collar jobs/professions which add much less value to society than a blue collar screw turner.
The majority of them are in the financial sector and the legal sector.

Both the number of people in such engaged in such unproductive (or actively harmful) work as well as their compensation has increased greatly since the 80s, with the financial sector more than doubling in size during that time and gobbling up a large part of total GDP profits.
The growth of the parasitical financial sector in the US as well as in other countries correlates with stagnatign wages for the rest of the economy.

http://tcf.org/blog/detail/graph-how-the-financial-sector-co...

http://en.wikipedia.org/wiki/Financialization

The most obvious reason why the cancerous growth of high finance is depressing wages at the middle and lower end is that it creates enormous demand for elite white collar workers but very little demand for blue collar workers.
The net effect on the economy is similar as if each year, a substantial portion (let's say 30 percent) of the top half of all university graduates were stood up against the wall and shot.

The net effect is that there are fewer engineers, physicists, doctors, programmers and managers (people who actually add value to society) available, economic growth is lower and a bigger share of resources flows to high-end white collar workers, making everyone else poorer.
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But if all or most companies have these new low labour costs, should we really expect them to all be more profitable? That is my basic question.

Very interesting question. If everybody at the parade stands on their tiptoes, no one gets a better view than they used to, but you do add one extra row of consumers getting a good view. That is, if market competition operates fast enough, it is the consumer that benefits from the lower labor costs.

There are plenty of things that can stop this, perhaps only a minority of companies are able to exploit the cheaper labor, so their cheaper labor gives them a price advantage but they don't produce enough with it to take over the whole market, and so they benefit from the same price as their competitors who can't exploit the cheap labor, in which case it mostly falls to their bottom line.

Probably in the short run it is a mix of both that happens, some benefit to consumers some to producers. In the long run, its the consumers all the way, assuming we are still alive.

R:
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