My email to Tony Jackson at Financial Times:
2010/1/18
Dear Mr. Jackson,
That was a fantastic read. I have forwarded it to everyone I know in investment banking, although probably their frequent reference Prof. Damodaran would make an ideal recipient.
I have two arguments to challenge your thoughts.
1) Philosophical argument: Are we concluding here that while prices change, value remains the same? How does it matter, since human decisions are driven by current prices more than by the value. For example, a man dying of thirst on 18th January 2010 may not reach the life saving (value driven) decision if he has the choice of spending his last 500 dollars on (a) buying a bottle of water or (b) buying one kilo of gold sold for 500 dollars. Probably that's the reason why Avatar (gold i.e. $1.3 billion) is more exciting than Gone With The Wind ($26 billion i.e. life…much more valuable than gold!).
2) Statistical argument: While I fully agree with your rationale, please consider this. If you apply the 'double discounting' of inflation and available resources, I wonder how the pre-crash 2007 US house prices appear. Probably you would end up concluding that the house prices in a previous boom were higher than those in 2007. Same for gold and oil? We all know available oil reserves are lesser today than in an earlier oil boom. Sorry for my laziness in not using the actual data and showing the conclusions. Also, I may not replicate your exact number crunching so results may not be comparable. However, you might want to do (or may have done) this and share with me how this theory fits with US house prices, gold and oil.
Regards,
Chetan
-----------------
From: Tony Jackson [mailto:tonyjackson09@googlemail.com]
Sent: Monday, January 25, 2010 7:39 PM
To: Chetan Shah
Subject: Price and value
Chetan - my apologies for this belated reply. On the philosophical point, I think the distinction between price and value is fair enough. But my own point was rather more basic - the distinction between price and affordability. If the price of a thing has doubled but wages have quadrupled, we can all afford twice as much of it as before. Whether it is rational to buy twice as much of the thing - cigarettes, say - is of course a different question.
As to historic prices, I bought my first house (in Edinburgh) for £12,000 in 1978. Adjusted for UK average earnings, that makes £83,000 today. Since that's half the UK average house price today, I infer that house prices are now more expensive. And the gold price, as I recall, was nearly $800 at its peak in 1980 - around $3,000 today on average GDP per head. Still some way to go there ....
Regards,
Tony
--------------------
My response email to Tony Jackson on 26/1/2010:
Tony,
I hate to drag this into a further argument, but can't resist.
Would you say that gold is unlikely to reach $,3000 any time soon? Would you also say that your friends/wife/doctor from Edinburgh i.e. the market does not expect house prices in Edinburgh to fall by 50%? I am tempted to believe so, because I guess most of us do not live by statistics but by real physical experiences and the current - nominal - numbers appeal to us more than the real - discounted - numbers. Probably our priorities change, too and that reflects in our spending patterns breaking out of old expense/earning ratios.
I am certainly not sharing your thoughts on gold with my wife and give her a reason to buy more.
Thanks for your response and hope to read more of your brain stimulants!
Cheers!
Chetan
Saturday, 13 February 2010
Friday, 12 February 2010
Why Avatar Is Not Such A Big Hit...by Tony Jackson, January 16,17 Financial Times
I read the following brain scratcher in FT a few weeks ago...worth a read.
Frankly my dear, that record has gone with the wind
The 3D film Avatar is apparently doing well at the box office. Its $1.3bn sales to date put it in contention with the record holder Titanic (1997), at $1.8bn, and eclipse Gone With The Wind (1939), which managed $390m.
Or so the publicity tells us. But for anyone with an ounce of numeracy, this is nonsense. Adjusted for US inflation,Titanic's sales were $2.4bn and Gone With The Wind's getting on for $6bn. Add another pinch of numeracy and a further thought occurs.
Inflation apart, real incomes rise over time. If a thing cost $10 in 1980, the question is not just what it would cost today, but what it cost then in terms of available resources.
Applying that logic to box office sales, let us adjust for nominal US gross
domestic product per head (a proxy for average wages), which I derive from
measuringworth.com. By that yardstick, Gone With The Wind's sales are worth a rather daunting $26bn in today's money.
As with Hollywood, so with Wall Street.
Today's reader of JK Galbraith's The Great Crash 1929 might find the sums involved rather trivial, since the Dow Jones Industrial Average peaked back then at a mere 380. But do the same adjustment for nominal GDP per head, and the level was more than 21,000.
That is thought-provoking. It has become almost conventional wisdom today that the 2000 peak of 11,700 on the Dow was a record level of overvaluation, based on the twin measures of the 10-year rolling
inflation-adjusted price-earnings ratio and the "q" ratio of price to book value. But even ,adjusted for GDP, that was less than 16,000 in today's terms. All the same, the 2000 peak was higher in that respect than any in history except 1929. It was higher even than the nominal 14,000-odd
which immediately preceded the latest crisis in 2007.
What do these comparisons tell us?
First, distinguish between the two measures. The cyclically adjusted real p/e, developed by the US economist Robert Shiller, works on the basis of reported corporate earnings rather than broad economic activity. The two are, of course, intimately linked. But corporate profits as a proportion of GDP fluctuate over time, depending on the bargaining power of capital versus labour. Those fluctuations tend, naturally enough, to be mean-reverting, that is, they vary around a fairly constant average.
Hence the calculation by Smithers & Co that the 2000 valuation peak was a record, based on deviation from the long-run mean. Our "real" valuation of stocks, based on GDP, is rather different. It tells us, in effect, what level of available resources the population has been willing to devote, to ownership of corporations.
The size of the quoted sector, of course, varies over time. But that need not concern us, since we are measuring an index rather than total dollars.
When we look at the reality of economic growth, the picture is one of false
projections from past experience. Average growth in the US economy in the 1920s was 4 per cent a year, and in the 1930s half that. As ever, the 1929 market peak was just in time to be too late.
In the 1990s, which led up to the next market peak, US growth was a more
subdued 3.3 per cent, a reflection of the fact that the rate had been slowing ever since the 1960s. But the figure for the 2000s looks like being being a close tie with the 1930s for the worst on record. The best decade for growth, on the other hand, was the 1940s - a clear case, you
might think of a rebound from the depths encouraging signal for the 2010s.
But when we recall the enormous impetus given to the US economy by the second world war, we might perhaps temper our hopes. All that said, let us return to our basic premise. It is encouraging that in real terms, the market excesses of the past decade have not matched those of the
1920s. Equally, it no longer seems likely that the world will slip into a 1930s-style depression, though you never know. But given the glum outlook for developed world profits in the changed conditions of the new decade, it remains less than comforting that the market should be as high as it is. Let us recall that in the other great bar market of the past century, in the mid-197Os, the peak in today's adjusted terms was only about
7,700.
Look on the bright side. We were never daft enough, it seems, to pay the kind of prices for stocks our great-grandparents did. And if truth be told, I was never that keen on Gone With The Wind either.
Frankly my dear, that record has gone with the wind
The 3D film Avatar is apparently doing well at the box office. Its $1.3bn sales to date put it in contention with the record holder Titanic (1997), at $1.8bn, and eclipse Gone With The Wind (1939), which managed $390m.
Or so the publicity tells us. But for anyone with an ounce of numeracy, this is nonsense. Adjusted for US inflation,Titanic's sales were $2.4bn and Gone With The Wind's getting on for $6bn. Add another pinch of numeracy and a further thought occurs.
Inflation apart, real incomes rise over time. If a thing cost $10 in 1980, the question is not just what it would cost today, but what it cost then in terms of available resources.
Applying that logic to box office sales, let us adjust for nominal US gross
domestic product per head (a proxy for average wages), which I derive from
measuringworth.com. By that yardstick, Gone With The Wind's sales are worth a rather daunting $26bn in today's money.
As with Hollywood, so with Wall Street.
Today's reader of JK Galbraith's The Great Crash 1929 might find the sums involved rather trivial, since the Dow Jones Industrial Average peaked back then at a mere 380. But do the same adjustment for nominal GDP per head, and the level was more than 21,000.
That is thought-provoking. It has become almost conventional wisdom today that the 2000 peak of 11,700 on the Dow was a record level of overvaluation, based on the twin measures of the 10-year rolling
inflation-adjusted price-earnings ratio and the "q" ratio of price to book value. But even ,adjusted for GDP, that was less than 16,000 in today's terms. All the same, the 2000 peak was higher in that respect than any in history except 1929. It was higher even than the nominal 14,000-odd
which immediately preceded the latest crisis in 2007.
What do these comparisons tell us?
First, distinguish between the two measures. The cyclically adjusted real p/e, developed by the US economist Robert Shiller, works on the basis of reported corporate earnings rather than broad economic activity. The two are, of course, intimately linked. But corporate profits as a proportion of GDP fluctuate over time, depending on the bargaining power of capital versus labour. Those fluctuations tend, naturally enough, to be mean-reverting, that is, they vary around a fairly constant average.
Hence the calculation by Smithers & Co that the 2000 valuation peak was a record, based on deviation from the long-run mean. Our "real" valuation of stocks, based on GDP, is rather different. It tells us, in effect, what level of available resources the population has been willing to devote, to ownership of corporations.
The size of the quoted sector, of course, varies over time. But that need not concern us, since we are measuring an index rather than total dollars.
When we look at the reality of economic growth, the picture is one of false
projections from past experience. Average growth in the US economy in the 1920s was 4 per cent a year, and in the 1930s half that. As ever, the 1929 market peak was just in time to be too late.
In the 1990s, which led up to the next market peak, US growth was a more
subdued 3.3 per cent, a reflection of the fact that the rate had been slowing ever since the 1960s. But the figure for the 2000s looks like being being a close tie with the 1930s for the worst on record. The best decade for growth, on the other hand, was the 1940s - a clear case, you
might think of a rebound from the depths encouraging signal for the 2010s.
But when we recall the enormous impetus given to the US economy by the second world war, we might perhaps temper our hopes. All that said, let us return to our basic premise. It is encouraging that in real terms, the market excesses of the past decade have not matched those of the
1920s. Equally, it no longer seems likely that the world will slip into a 1930s-style depression, though you never know. But given the glum outlook for developed world profits in the changed conditions of the new decade, it remains less than comforting that the market should be as high as it is. Let us recall that in the other great bar market of the past century, in the mid-197Os, the peak in today's adjusted terms was only about
7,700.
Look on the bright side. We were never daft enough, it seems, to pay the kind of prices for stocks our great-grandparents did. And if truth be told, I was never that keen on Gone With The Wind either.
Economic Theory of Divorce: FT Responds - January 23,24 Weekend Edition 2010
While I am not happy the way Tim Harford responds to my economic wisdom, I am quite flattered I could reach out to the world's most influential people of business and finance who read FT.
Dear Economist: Resolving readers' dilemmas with the tools of Adam Smith
Should we rethink the reasons for divorce? The betting markets reckon Elin Nordegren will divorce Tiger Woods. Given the experiences of The wives of Shane
Warne and Bill Clinton, that seems hasty. Warne’s wife tolerated his scandals for years before divorcing him. Cricketers do not make as much money as golf stars, so the probability of her receiving a large alimony was low. Hillary Clinton had a much
lower probability of political success as a divorcee. should look at economic rather than emotional reasons for divorce.
Chetan S.
Dear Chetan,
You need to clarify your reasoning. You contrast Shane Warne's earnings with those of Tiger Woods, which suggests you have in mind some kind of income effect, where the richer the husband, the more likely the wife is to divorce him. This has the merit of being a falsifiable theory, but I am not sure it is true. Such cases belong instead to the theory of the firm. When two units of production - Hillary and Bill, say - are worth more together than they are separately, we call them "complementary assets", and there is a strong reason to keep them together. It's a question of how annoying the affairs are versus how strong the
complementaries are. Hillary and Bill are complementary assets; this is less obvious for Nordegren and Woods. As for a general theory, there is plenty of data - a project for a student of economics such as you?
Tim Harford
Questions to economist@ft.com
Dear Economist: Resolving readers' dilemmas with the tools of Adam Smith
Should we rethink the reasons for divorce? The betting markets reckon Elin Nordegren will divorce Tiger Woods. Given the experiences of The wives of Shane
Warne and Bill Clinton, that seems hasty. Warne’s wife tolerated his scandals for years before divorcing him. Cricketers do not make as much money as golf stars, so the probability of her receiving a large alimony was low. Hillary Clinton had a much
lower probability of political success as a divorcee. should look at economic rather than emotional reasons for divorce.
Chetan S.
Dear Chetan,
You need to clarify your reasoning. You contrast Shane Warne's earnings with those of Tiger Woods, which suggests you have in mind some kind of income effect, where the richer the husband, the more likely the wife is to divorce him. This has the merit of being a falsifiable theory, but I am not sure it is true. Such cases belong instead to the theory of the firm. When two units of production - Hillary and Bill, say - are worth more together than they are separately, we call them "complementary assets", and there is a strong reason to keep them together. It's a question of how annoying the affairs are versus how strong the
complementaries are. Hillary and Bill are complementary assets; this is less obvious for Nordegren and Woods. As for a general theory, there is plenty of data - a project for a student of economics such as you?
Tim Harford
Questions to economist@ft.com
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