Tuesday, February 2, 2016
Are US Stocks Overvalued?
The recent decline in US stock prices has caused many investors to worry about the return on US stocks. Olivier Blanchard gives his answer to the question. He looks at several ways to evaluate the return on stocks over time, using the price to earnings ratio, and he argues that there is a better way to answer the question. He changes the question by comparing the return on stocks to the expected return on bonds. The expected return on stocks is a function of dividend growth. He assumes that dividends will grow at the expected rate of GDP growth. Since the market anticipates low interest rates well into the future, the return on bonds will continue to be lower than the return on stocks. Therefore, stocks are not overpriced compared to the return on bonds. The equity premium will continue into the near future as long as anticipated growth in GDP and interest remain constant.