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The US stock market and the global economic crisis

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  • Wadhwani, Sushil B.

Abstract

The question whether the US equity market is overvalued is important from a policy perspective because a significant derating could interact adversely with the realisation of risks of recession. A simple dividend based model suggests that the market is two or three times overvalued. Allowing for stock buybacks, takeovers for cash and temporary unsustainable earnings growth leave the market overvalued by 20–30 per cent. The ‘New Economy’ view that recessions are things of the past and that technical change justifies permanently higher earnings growth is implausible. An influential argument that the traditional premium earned by equities over bonds is too high is itself theoretically special. Similarly the recent relationship between US inflation and the risk premium has not held at other times and places, while the fact that most wealth is held by middle-aged people with limited time horizons supports a larger premium. Our best guess is that the current premium is 1.7 per cent p.a. which is near the lower end of the historical range although equity investors do not appear to be prepared for lower returns in the face of the possibility of global recession in the next 12–18 months. The risk that a US market adjustment might aggravate such a recession in the US itself is a basis for reconsidering central banks' disregard of asset prices in setting monetary policy.

Suggested Citation

  • Wadhwani, Sushil B., 1999. "The US stock market and the global economic crisis," National Institute Economic Review, National Institute of Economic and Social Research, vol. 167, pages 86-105, January.
  • Handle: RePEc:cup:nierev:v:167:y:1999:i::p:86-105_10
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    Cited by:

    1. Roelof Salomons, 2008. "A Theoretical And Practical Perspective On The Equity Risk Premium," Journal of Economic Surveys, Wiley Blackwell, vol. 22(2), pages 299-329, April.

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