Yes, but when the stock becomes overvalued, it does not hurt the underlying real economy. Overvalued stock even helps investments in true capital.
"The Great Crash of 1929 happened on the stock market, not in the real estate market. "
There are also opinions, that this was also about land market.
"It's just that real estate markets have been politically expedient to create bubbles in for the last couple of decades, because real estate is the asset class that Main Street owns and feels comfortable with."
Of course they are comfortable, because land values always rise. As long as there is education, developing infrastructure and population growth. No Einstein is needed to cash in land market. What makes real estate (or in fact land market) a whole more serious is that the money gained is economic rent, not lottery money from other gamblers. Just a payment from production to privilege (nothing really happens). These bubbles leave labour and true capital in debt for decades. And take down all the production in the whole economy.
I just add that not all "Main Street" owns Real Estate. I believe that in fact it is quite a selected group that really owns land and takes the "rent" from economy. Of course average Joe likes to see his/hers real estate value grow, but in both cases, it is in the end economic rent they cash in.
- Jake If you only spend 20 minutes of the rest of your life on economics, go spend them here.
And when, as happens at some point in all bubbles, the price of the stock no longer reflects the value of the underlying cash flows
Even without bubbles it's astonishing how rarely stock prices reflect trading fundamentals.
But usually they reflect at least some tenuous approximation of the fundamentals. You don't get a company with a hundred million in assets and liabilities of 90 million with a market cap of two hundred million unless you have a bubble. It might have a market cap of a fifteen million one day and eight million the next, because stockholders can't decide on how to value the hard-to-value bits on the balance sheet. But there are limits to the craziness in normal times.
P/E ratios, for instance, have historically not been all over the place, except in the run-up to a panic.
Overvalued stocks do real damage to the real economy in several ways:
A great depression is a bastard of many fathers, and I would be surprised if persistent stock price inflation didn't also inflate real estate prices. But the major contraction in the money supply and the major contraction in aggregate demand both arose from stock writedowns.
Of course they are comfortable, because land values always rise. As long as there is education, developing infrastructure and population growth. No Einstein is needed to cash in land market.
Face values go up, but inflation-adjusted prices don't necessarily go up. And even when they do, you won't necessarily be better off buying than renting. That depends on tax codes, interest rates, rents, inflation and a lot of other variables. One such analysis can be found here, courtesy of the always great khanacademy.
Not in the long term. But you can't always say the same from a certain stock. Also playing "waiting-game" always wins in the land market. You don't lose market share (or wealth) doing it. But when we talk about "bubbles", land market is always a true "Eldorado" for banks and speculators.
"And even when they do, you won't necessarily be better off buying than renting. That depends on tax codes, interest rates, rents, inflation and a lot of other variables. One such analysis can be found here, courtesy of the always great khanacademy."
If you seek quick profits, of course you never rent anything. In this article is a graph about land and housing prices from last years:
http://www.moneyweek.com/investments/property/house-prices-expect-the-worst.aspx
Not in the long term. But you can't always say the same from a certain stock. Also playing "waiting-game" always wins in the land market.
Only if you can afford to wait that long. Real, inflation-adjusted land prices may easily be higher today in many parts of the US and UK than they will be again within my lifetime.
When prices do a random walk, if you can wait long enough you can recoup any loss of book value. That's just another way of stating the Gambler's Ruin: If you have the (sufficiently) bigger bank, you can't lose unless the game is systemically tilted against you.
But very, very few people in the real world can afford to wait for arbitrarily long lengths of time. As Keynes famously said, "the market can stay irrational longer than you can stay solvent." In other words, even when there is a bias in your favour, you may not always be able to wait long enough to make a profit. Nevermind the case where prices are a random walk.
Real land prices (land values) can only be higher today than tomorrow, if productivity drops, infrastructure gets worse and/or population declines. Market price naturally changes. If you can afford to put money in the bank, you can afford to sit on your land assets. There is only usually just some 1% property tax. Already the average growth in productivity covers that "risk". The problem with Keynes is that he doesn't make the difference between "capital" and "land", even these are very different in nature.
And in fact, housing has, in the US and UK, been grossly overvalued. And that bubble just popped. So prices will go down, and likely stay down for quite a while.
