Re: Evidence Against the Market Bubble Story

From: Ross A. Finlayson (
Date: Wed Jun 14 2000 - 13:14:44 MDT wrote:

> Robin writes:
> > I once here cited analysis by Robert Shiller that suggested
> > the current stock market was in a bubble. However, I just came
> > across relevant analysis by J. Bradford Delong, who I have other
> > reasons for respecting. He finds that long term fluctuations
> > are probably rational, while short term ones can be irrational.
> I found a web page for Brad DeLong, at
> He's got
> some fascinating essays there. He writes a new article every week and
> you can subscribe to them. Sounds like he'd be a great guy to have as
> your econ prof.
> > "Why Does the Stock Market Fluctuate?"
> > Robert B. Barsky, J. Bradford De Long
> > Quarterly Journal of Economics,
> > Vol. 108, No. 2. (May, 1993), pp. 291-311.
> >
> I couldn't access this, but I found a 1990 essay on his web site at
> This one made
> much the same point, that stock prices are rational over the longer term
> (10 years), assuming that investors extrapolate recent dividend rates
> into the future and determine prices based on expected dividend flows.
> He shows a graph (his figure 4) of actual stock prices over the last
> century, compared to what his model predicts, and they are in very close
> agreement visually.
> However upon closer study, I noticed some things which made me more
> skeptical. His model often lags the actual stock price movements.
> This is especially noticeable in the 1929 crash. The actual market peaked
> in 1929. But his predicted prices continue to climb and peak in 1931.
> It is easy to see why, given his model. He predicts stock prices based
> on recent years' dividends. In 1929, dividends were still showing a
> pattern of growth in recent years. It wasn't until the early 30s that
> declines in dividends causes his predicted prices to fall.
> But actually you can argue that the drop in dividends in 1930 and
> onward was caused in part by the stock market crash. Obviously all
> these effects are interrelated and it is hard to single one out, but
> the crash surely played a contributory role in the economic slowdown.
> As prices fell, people were wiped out, loans went bad, and there were
> widespread spending reductions.
> It seems, therefore, that the stock market crash led to dividend
> reductions, which then caused his model to predict a stock market crash.
> But that's not a good prediction because the causative condition only
> occured after the supposed effect.
> Does his more recent paper extend this analysis?
> Also, whenever I read these kinds of papers I want to see whether the
> analysis works when extrapolated forward. DeLong had results up through
> the late 1980s. The last decade has been remarkable in its stock market
> performance. Would his model successfully predict price movements in
> the 1990s? My guess is that it would predict a strong bull market, as
> the continued economic expansion has presumably produced dividend growth.
> However I doubt that it would predict the degree of increase the market
> has actually seen, with P/E ratios much higher than historical averages.
> Hal

I'm not an economist, nor do I know much about real-world economics, but as part of
my studying international economics major with statistics whilst in college, I
formulated a paper and the numbers (with ANOVA and ANCOVA or something) showing a
direct correlation between government expenditures categorized as R+D and later
growth. So, basically, the forecaster of growth is research and development
expenditure, although too much has the negative side effect of cutting other costs.

I can't say what this has to do with the stock market which is somewhat irrational,
not to mention for many a rip-off, but it is my opinion that there is enough
research and development not to mention productivity growth bootstrapped from
computer and network productivity enhancements that make certain old-school
predictors of growth conservative and perhaps even invalid. In the new model,
expected growth should be and is higher, and throttling it with interest rate hikes
is negative in regards to what it is as non-inflationary growth.

I could be wrong.

I got the data from something like GAO reports. I always thought this site was


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