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Economy & Business

Commentary: Is the stock market engaged in irrational exuberance?

This article first appeared in the St. Louis Beacon, April 19, 2013 - The stock market is setting new nominal highs. Gas prices are not going through the roof. And just when you thought it looked as though the recovery would gain steam, some economist comes along to write that things are not as good as we thought.

We are nearing the release date (April 26) for our first glimpse at first-quarter GDP, the measure of goods and services produced in the economy, adjusted for inflation. The mounting evidence indicates that it will not be as quick as previously thought.

One estimate is that first quarter GDP growth will come in at 3 percent. This prediction appeared as the April 12 blog post of the respected forecasting Macroeconomic Advisers. A slight reduction from an earlier forecast of 3.3 percent growth, this reflects slower sales that, some have argued, reflect consumers’ negative response to the payroll tax increases that occurred on Jan. 1.

Now a 3 percent rate of growth in GDP isn’t bad. But it’s not a growth rate that will push us out of the slow-traffic lane we’ve been in for some time.

That slow growth is impacting and being impacted by other key areas of the economy. Take the housing market. Just a few months ago the housing market was poised to renew its building spree and pull the economy out of its doldrums. Or so many observers announced.

That belief has changed. The National Association of Home Builders/Wells Fargo Housing Market index released April 15 indicated that home builders’ enthusiasm is muted. Sentiment among builders polled has fallen over the past three months. The index today stands at 42, a drop from the previous month’s rating of 44. More important, a value less than 50 suggests continued decline. 

But what about recent increases in housing prices? Rising prices are a signal that buyers are returning to the market, and that is good. But rising prices do not guarantee that housing is on the mend. Robert Shiller, co-creator of the Standard & Poor’s Case-Shiller house price index, argues that short-term bumps in housing prices may not mean much. “After correcting for inflation,” Shiller notes in a New York Times article, short-term changes in housing prices “have had almost no statistical relationship to increases 10 years down the road.”

Isn’t the labor market recuperating? The good news is that the most recent unemployment rate of 7.6 percent is lower than the rate one year ago, when it was 8.2 percent. 

The overall unemployment rate masks important developments in the labor market, however. Add in those individuals who dropped out of the labor force, the so-called discouraged workers, and the current unemployment rate jumps back above 8 percent. Being a discouraged worker represents a miss-match in the market: You are not willing to accept market wages that are below your previous earnings, or your skills are no longer in demand. 

This latter possibility reflects an important factor driving today’s labor market. It is evident from the data that unemployment is inversely related to educational attainment. In the March data, those with less than a high school diploma (those who had not already left the labor force) faced an unemployment rate of 11.1 percent. This compares with 3.8 percent unemployment rate for those with a bachelor’s degree and higher. While these two groups are characterized by differing socio-economic traits, more education increases the probability that you will be employed. 

The economy’s lackluster rebound from the Great Recession continues to confound policymakers and pundits alike. The Fed has pushed rates to zero and held them there for an extended period. Seemingly dysfunctional fiscal policy has added stimulus to the economy, though without apparent lasting effect.

What about the soaring stock market? If equity prices are investors’ forward looking evaluations of companies’ earnings potential, maybe the market sees something in the data that escapes other eyes?

Rik Hafer is a distinguished research professor in the Department of Economics and Finance at Southern Illinois University Edwardsville and a scholar at the Show-Me Institute.

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