The central idea of CCH is shown by this figure:
![[Image: Inequal-cap-prod.gif]](http://mikebert.neocities.org/Inequal-cap-prod.gif)
Shown is a measure of economic inequality and a measure of capital productivity: per capita GDP (GDPpc) divided by R. R is sort of a real equity or book value. During "normal" times (when GDPpc is around 40) P/R works well for valuation as do similar measures like Shiller P/E or Tobin's q. During these special times (like now) when capital productivity is depressed, to obtain a good measure of valuation it is necessary to correct for profit market as I did here. Basically I take raw P/R and multiply by 42/ capital productivity:
corrected P/R = raw P/R * 42 R /GDPpc = 42 * P/GDPpc
This expression is analogous to the ratio of total GDP to total market capitalization. Fund manager Jon Hussman notes this same thing:
Though it’s not widely recognized, measures such as the ratio of market capitalization/nominal GDP and the S&P 500 price/revenue ratio are actually better correlated with actual subsequent total market returns than price/operating earnings ratios, the Fed model, and even the raw Shiller P/E (though the Shiller P/E does quite well once one adjusts for the embedded profit margin).
What Hussman and I are getting at is most market observers (including the Fed) don't see the bubble in stocks because according to conventional valuation measures like P/E (especially when adjusted for the very low interest rates) do not show evidence of overvaluation. What few notice is this was true in 1929. The market was NOT extremely overvalued in 1929 by conventional measures. But based on what happened after, it sure was. When you use the adjusted P/R it shows up as the highest valuation in history up to that time (only 2000 surpasses it). Today is #3, but we are still going up.
Even Hussman is unconcerned about what is doing because he sees a 40% drop, based on using the entire dataset for reference. In my analysis I assume that we are still in a secular bear market (i.e. we be 4T) and so we need to restrict our comparisons to previous secular bear markets. This indicates a larger drop on the order of 55%. The only two declines of this size or greater (1929 & 2008) were both associated with financial crisis. Looking at the larger picture five of the ten greatest declines has panics. So there is a 50-100% chance of another financial panic. But since we are 4T, it will be 100%.
The Fed is out of ammunition. Any ameliorative measure from this crisis will have to come from the Republican Congress in service to a Democratic president whom they want to see fail. They have every incentive to let the economy collapse. Now the last time we had a massive stock market drop and panic with a passive government, this is exactly what happened.
When a capitalist economy simply stops working and the primary capital market (i.e. the center of a capitalist) ceases to function in a rational manner, you have a crisis in capitalism. Businessmen will start to question what they believe about the way things work. They will also start to fear the people who have shown a rising taste for radical or populist measures on both the left and right. A critical mass may come to see Clinton as their last best hope, much as they did
Shown is a measure of economic inequality and a measure of capital productivity: per capita GDP (GDPpc) divided by R. R is sort of a real equity or book value. During "normal" times (when GDPpc is around 40) P/R works well for valuation as do similar measures like Shiller P/E or Tobin's q. During these special times (like now) when capital productivity is depressed, to obtain a good measure of valuation it is necessary to correct for profit market as I did here. Basically I take raw P/R and multiply by 42/ capital productivity:
corrected P/R = raw P/R * 42 R /GDPpc = 42 * P/GDPpc
This expression is analogous to the ratio of total GDP to total market capitalization. Fund manager Jon Hussman notes this same thing:
Though it’s not widely recognized, measures such as the ratio of market capitalization/nominal GDP and the S&P 500 price/revenue ratio are actually better correlated with actual subsequent total market returns than price/operating earnings ratios, the Fed model, and even the raw Shiller P/E (though the Shiller P/E does quite well once one adjusts for the embedded profit margin).
What Hussman and I are getting at is most market observers (including the Fed) don't see the bubble in stocks because according to conventional valuation measures like P/E (especially when adjusted for the very low interest rates) do not show evidence of overvaluation. What few notice is this was true in 1929. The market was NOT extremely overvalued in 1929 by conventional measures. But based on what happened after, it sure was. When you use the adjusted P/R it shows up as the highest valuation in history up to that time (only 2000 surpasses it). Today is #3, but we are still going up.
Even Hussman is unconcerned about what is doing because he sees a 40% drop, based on using the entire dataset for reference. In my analysis I assume that we are still in a secular bear market (i.e. we be 4T) and so we need to restrict our comparisons to previous secular bear markets. This indicates a larger drop on the order of 55%. The only two declines of this size or greater (1929 & 2008) were both associated with financial crisis. Looking at the larger picture five of the ten greatest declines has panics. So there is a 50-100% chance of another financial panic. But since we are 4T, it will be 100%.
The Fed is out of ammunition. Any ameliorative measure from this crisis will have to come from the Republican Congress in service to a Democratic president whom they want to see fail. They have every incentive to let the economy collapse. Now the last time we had a massive stock market drop and panic with a passive government, this is exactly what happened.
When a capitalist economy simply stops working and the primary capital market (i.e. the center of a capitalist) ceases to function in a rational manner, you have a crisis in capitalism. Businessmen will start to question what they believe about the way things work. They will also start to fear the people who have shown a rising taste for radical or populist measures on both the left and right. A critical mass may come to see Clinton as their last best hope, much as they did