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Stock market volatility leaves investors with tough long-term choices, economist says

Wednesday, April 04, 2018

LAWRENCE — The finance market turmoil that many analysts feared ahead of the 2016 election may only have been delayed, not avoided, according to a University of Kansas expert on finance and economics.

Monday's 2.2 percent decline in the Dow and the even larger decline in the Nasdaq index were precisely the sorts of shocks critics of President Donald Trump's policies feared but that seemingly never materialized. Stocks partially recovered on Tuesday, but it seems unlikely that the market turbulence has ended, said George Bittlingmayer, professor emeritus in the KU School of Business.

"In the short term, Trump's critics were proven wrong. In the longer term, the alarms they sounded may still be on the mark. Unbounded optimism often sets the stage for panic, but the panic may at least partly reflect real fears," Bittlingmayer said.

Bittlingmayer has done extensive research on the origins of famous booms and busts such as occurred during Teddy Roosevelt's time in office, again in the 1920s and more recently in the 1990s and the end of the Internet Bubble. He is the former Wagnon Distinguished Professor of Finance in the business school and previously served as an economist at the Federal Trade Commission. He is available to comment on recent trends in the stock market.

"We've had a period of boom and optimism, similar to what we saw in the 1920s, 1980s and again in the late 1990s and in the period leading up to 2008," he said. "Plausibly, in all those cases, the market was overvalued, either temporarily or for several years. In all those cases also, real or feared political initiatives on trade or on large, successful corporations were the apparent stimulus for a reassessment by investors. Where current policy initiatives will go is, in fact, hard to predict."

Based on well-known and robust measures of stock valuation, Bittlingmayer said the U.S. stock market is still richly valued, reflecting a very long bull market that started in 2009 and that was seemingly immune from the sort of market retreats that afflict highly valued markets, until the market peak in January.

"However, even if one accepts overvaluation as a fact, predicting when stocks will come down, and whether a decline will happen gradually or suddenly, is hazardous," he said. "It is a bit like predicting earthquakes for California. We know that California will someday experience both large and small earthquakes. We just don't know when."

Similarly, analysts and researchers feel safe in predicting that the value of stocks relative to robust measures of long-term earnings potential will come down, but they don't know whether it will do so sooner or later. As a result, knowing that assets are overvalued has little practical value.

Being right too soon is the same as being wrong is an old market adage, Bittlingmayer noted.

"For investors, the situation involves difficult choices between bonds that still have historically low yields," Bittlingmayer said, "and a stock market that will be hard-pressed to deliver long-term returns comparable to what we have seen over the last century."

To some, it might make sense to welcome some of the stock market corrections that seem to have come from President Trump's pronouncements and actions on trade, pending mergers or the business models of companies like Amazon, he said. On that view, it's better to take a smaller hit to stock prices now rather than experience a continued run-up and a much larger hit later on.

"That may be the case, but the real long-term danger from economic policy that hurts markets stems from actions that hurt the economy over many years and the earnings potential of business in general," Bittlingmayer said.

To arrange an interview with Bittlingmayer, contact George Diepenbrock at 785-864-8853 or gdiepenbrock@ku.edu.

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