22 12 2014
The US stock market: Good as gold?
The world economy is a mess. The US seems to be a bright spot, although its slow recovery is a bit spotty and seems to be benefiting the already-wealthy more than those trying to move in that direction. China’s economy is still growing, but slowing, and it faces long-term hurdles in clearing up pollution and corruption, along with questionable security for companies in a political system where the “rule of law” seems a bit arbitrary.
When the world is facing significant economic challenges, a historical response has been a “flight to gold,” supposedly a secure commodity that reflects some intrinsic value that is beyond the power of individual countries to destroy. But if the price of gold closes at its current price at the end of the year, that would constitute a slight loss on the year, the first back-to-back yearly loss since 1997, suggesting that gold no longer plays this role.
In August, I argued in this blog that the US stock market was the new gold standard, with the value of US companies the real measure of what the dollar could buy in an era where there is no commodity backing money—no gold standard. A logical conclusion is that money will flow to the new gold standard rather than to gold when world economies struggle.
Perhaps this is why the US stock market seems relatively immune to bad news. The S&P 500 index has grown about 12% year-to-date and is near record levels. The US stock market is benefiting from bad news worldwide as a refuge for money that wants a relatively safe haven. And, despite the occasional chaos of a democratic political system, the rule of law in the US seems intact, at least to the extent that arbitrary government actions outside of those rules is difficult. That critical factor, combined with regulations requiring uniform financial disclosure for companies listed on the US stock market, has made that institution one where values of companies are based on relatively reliable information. The value of gold, on the other hand, seems more based on emotional expectations than some intrinsic utility.
The classical way to look at whether the stock market is at appropriate levels is the average price-to-earnings ratio (which isn’t particularly high today by historical standards). But perhaps there should also be a premium for the US stock market’s role in defining the value of a dollar and thus, as the world’s reserve currency, the value of every other currency in the world. The US stock market is benefiting from the current version of the “flight to gold.”