The S&P 500 and U.S. Household Wealth Have Reached Record Highs

Unfortunately, we do not live in a perfect world devoid of genocide and weapons of mass destruction. Thus, a world police is necessary unless you're willing to take your chances and see who the last man standing is--on Earth.

There are positives to being Switzerland--affluent and friends with everyone--but you can only get away with that for so long. If Nazi Germany had won, they would not have been left alone in the end.

People need to understand that we're animals and that we live in the jungle. That most of us have implicitly or explicitly agreed to suspend the rules of the jungle and not kill each other and take each other's stuff...for as long as possible. Disregard these at your own peril and on one extreme you'll find your family member on the modern equivalent of a milk carton and on the other wiped out in a Holocaust.

There must be a world police and everyone in the world should thank their lucky stars that it's the USA and not some other country.

I don't know, I'm glad the world police(UK and France) didn't interfere with the US during our civil war, sometimes you got to let people settle their own problems.

There are three things that must be considered:
(1) the "goodness" and motivations of the world police;
(2) that there's a difference between whether there should be a world police and whether that world police should or should not act/intervene in a given situation; and
(3) it's a whole lot easier to kill tons of people en masse today than it was centuries ago. Today we have AK-47s, ICMBs, tanks, nuclear submarines, land mines, and of course, nuclear, chemical, and biological weapons.

Great comment , thank you

Don't you think that the innovation part of America has gotten eroded relative to the 60s and 70s. Now, you will have to admit that the large part of innovation has many legal immigrants behind the scenes.

No, not at all. If anything, it's accelerating but people now take it for granted as information moves faster and it has become the new normal. I attended college in the 4 years between the autumn of 2001 and the spring of 2005. YouTube didn't exist - there was no way to watch old movie archives of major historical events, concerts, or speeches outside of going to a research library or finding a friend with a VHS or DVD. Smartphones had a fraction of the computing power, with the game-changing iPhone years from seeing the market; most students, at least in the beginning, still had landlines in their dorm room. Truly mobile computing (iPad, Surface) wasn't possible. Battery technology and solar energy capture was much less efficient. Natural gas extraction was far less advanced, which is now changing the nation's power grid in ways that would have seemed impossible. Private companies are organizing civilian space flights. The humble light bulb is now infinitely more advanced and efficient than it was back then. Film compression and quality has drastically improved. The discoveries and innovations in biology and genetics dwarf nearly everything that came before it as the rate of understanding compound geometrically. We have three-biological parent teenagers alive in the world, HIV cured with bone marrow transplants in some patients, great improvements in appliance design for better efficiency, radical upgrades in automobile car safety and efficiency. Skype wasn't widespread ten years ago yet you can now talk to people just like the Jetsons. And it's totally taken for granted.

I do worry a bit about innovation going forward because of a shift in corporate spending policies, which was best explained several years ago in this article, but I don't think we've quite seen the downside of that yet as it is still too early. It's also possible the universities that have replaced the corporate research labs might do better, or at least equal, work. We just don't know at present.

I do think there has been a cultural shift away from focusing on things such as the space program and science to bread and circuses, much to the detriment of everyone. But I think with a much larger population base, and the cognitive elite now being able to connect with each other so efficiently, you have these sub-cultures of radical innovation. In technology, it's centered around Silicon Valley. In medicine, it's up in Boston. In finance, it's in New York. In farm equipment, it's here in the Midwest. In oil, it's down in Dallas and Houston.

As for immigration playing a part, that has always been true in the United States. It's been the secret sauce for almost 200 years. We're a massive melting pot of different people coming together from different backgrounds. Einstein, living in Princeton, was an American, but he came here from Germany. Andrew Carnegie revolutionized steel production more than a century ago, and he came over from Scotland. This is not a new phenomenon. There seems to be something about seeing a culture with fresh eyes that makes spotting opportunities easier because you don't have the same assumptions built into your worldview.

"There seems to be something about seeing a culture with fresh eyes " i guess you are referring to being bi-cultural. I have read somewhere that people who are bi-cultural gain significant advantages and skills over those who are not. The thing is they do not even realize that them becoming bi-cultural is what lead to those gain in advantages.

The depth, breadth, and pace of innovation is staggering today. The exponential increase in computing power over the past several decades is the fuel in the engine. Most innovation is the culmination of a lot of incremental improvements which ironically may be why you perceive innovation to be slower.

Four examples I'll throw out at you - hyperloop, Watson diagnosing cancer, internet balloons, self-driving cars.

Our country has always been powered by immigrants since they work longer and harder. I'm not sure how that is different today other than what country they come from.

Joshua, a couple points I would like comments on:

1. Despite a record high aggregate net worth income inequality has widened in the U.S. Is the U.S. turning into a plutocracy?

2. Using the forward P.E. to value the market can be hazardous as it assumes the projected earnings estimates are accurate. By many other valuation methods the S&P is very expensive - likely due to record low interest rates. For example, Robert Schiller's cyclically-adjusted PE (something Benjamin Graham recommended when evaluating the earnings of companies), Market Capitalization to GDP ratio (Warren Buffett's favourite), and comparing with historical dividend yields despite more companies than ever before paying out dividends.

Any ratio is a relationship between two parts - it's possible for them to move out of sync, so the ratio won't give a perfect signal all the time. At present it seems like there are a few signals that the market may be moderately cheap (though not extremely cheap unfortunately), many that say it may be balanced, and a few that say it may be overpriced.

Joshua, I was also wondering about your thoughts on Shiller P/E levels right now, is that something you put any "stock" in (hate myself)?

I agree with Dr. Jeremy Siegal and Wharton that changes in accounting rules have resulted in biased underlying earnings data that distorts the value of the cyclically adjusted price-to-earnings ratio Shiller favors compared to its historical utility. Though it seems to be the most rational approach on the surface (I like the methodology), if the data isn't as accurate as possible, the conclusions must be suspect.

Siegel wrote about this back in August in an article in the Financial Times, pointing out that the new requirements 15 to 20 years ago now demand businesses write-off assets when they decline, leading to large reported losses, but forbids them from increasing the value when they increase, meaning the actual reported figures will be perpetually understated. As he puts it, "This change in earnings patterns is evident when comparing the cyclical behaviour of Standard and Poor’s earnings series with the after-tax profit series published in the National Income and Product Accounts (NIPA).", going on to illustrate that during the 2009 crash, the total losses by a handful of institutions such as AIG and Bank of America, which were confined to their own industry, decimated S&P earnings, yet had a far less powerful effect on the NIPA. Thus, to value the entire market based on an isolated, industry-specific bubble that resulted in that industry being destroyed is not an intelligent way to behave.

He recommends using the Shiller P/E but swapping the NIPA earnings for the new GAAP S&P earnings to get a better indication of over or undervaluation. At the moment, it shows the market is almost exactly rationally valued, which certainly matches my own conclusions using a bottoms-up approach where I'm looking at countless individual companies and running the numbers. Things aren't particularly cheap, nor are they particularly expensive.

Were one to argue for overvaluation in spite of these facts, he or she could make an argument that the increase in corporate profits as a percentage of GDP over the past few decades to a point high above historical levels is problematic, but I think that is not an intelligent line of reasoning given the massive increase in productivity driven by automation, technology, and software, the low-cost outsourcing to third world labor due to less restrictive international trade agreements, and the increasing percentage of corporate earnings that don't rely on American consumers, but instead come from overseas. It would be more intelligent to look at GNP as a significant percentage of corporate America's assets now exist outside the U.S. borders, in foreign countries, being staffed by foreign workers. Businesses are simply more profitable, and more efficient. Labor is cheaper. A car factory can be run with a handful of highly paid engineers. The Knowledge Revolution was just as transformative as the Industrial Revolution on assets such as steel mills.

TL;DR: I think Shiller's methodology for adjusting for inflation and averaging earnings is very intelligent, and the best approach, but I agree with Siegel that changes in GAAP rules have distorted recently corporate earnings figures relative to the underlying reality in some cases, resulting in the CAPE being biased to appear higher than it actually is.

Thanks for the detailed response! That makes a lot of sense, and reminds me why I don't even like thinking about the overall market. I would much rather try to break down individual companies.

1. The risk of plutocracy comes less from income inequality and more from the fact that the protections against it have been systematically dismantled over the past 40 years. There used to be strict FCC rules against media ownership consolidation to protect freedom of the press. Elections can now be bought and sold due to unlimited spending. Gerrymandering in all but name is obscene in some parts of the country. Tax rates are no longer equitable and fair, but specialized so someone earning $100 million pays a rate half that of someone earning $500k. Those specific things must be addressed before the generic idea of "income inequality", a significant portion of which is partially caused by assortative mating and women entering the workforce.

As for the United Nations Happiness Index (PDF), it's a non-scientific, subjective assessment of contentment based on things such as perception of freedom to make life choices and perception of political corruption. There is no calibration among cultures or populations to create a standard baseline. It's terrible science with very little usefulness that also has a significant bias against larger, diversified nations. For example, at #17 out of #156, the United States has a larger population than nations #1-16 combined. In a place like the U.S., most people are very happy with their local community, but unhappy with the nation as a whole. It's caused by what I wrote about the other day.

2. I generally detest using forward p/e ratios, and have written about it several times given the demonstrated, statistical tendency of analysts to significantly overestimate growth rates. I used it because that was the figure S&P had readily available and it wasn't that different from the current p/e ratio. It is almost November, so we're almost to the end of the fiscal year. Both metrics were historically in-line with the averages, so I didn't bother to clarify. But you're right; I am not a fan of using the forward p/e in general unless one agrees with the growth projections of the analyst.

As for the CAPE / Shiller p/e, read my other comments in this thread for a more detailed explanation. With the changes in GAAP accounting rules, I think it has turned what is a very good methodology (inflation adjustments, averaging cyclical earnings) into the sort of mindless thou-shalt-not-think absurdity you run into in other areas of life. People never stop to ask themselves whether the inputs, in this case the earnings figures, are still being calculated on a comparable basis (they're not). It's not enough to know the numbers. You have to know what is driving the numbers.

Also, a few technical notes:

A.) Buffett did not compare market capitalization to GDP. He compared to GNP, which includes foreign production by American owners and citizens. If you tried to look at equities relative to GDP, especially given the higher percentage of international revenues the country now experiences compared to the past, you're going to have a very bad time. It's going to cause stocks to appear wildly overvalued because you're making a mathematical mistake.

B.) Given the changes in the tax code and investor's increasing distaste for taxes, you can't look at dividend yields in isolation, you need to take the summation of dividend yields + share repurchases to estimate an effective yield as measured by return to stockholders. Exxon Mobil and McDonald's are nice examples - they earn enormous amounts of money each year, yet to maximize tax efficiency and avoid double taxation of dividends, a lot of capital is returned in the form of ever-shrinking shares outstanding. This was unheard of more than 40+ years ago, at least in any meaningful sense aside from a few capital allocation geniuses like Teledyne. Again, this is a case of actually thinking instead of blindly looking at numbers. The incentive system changed. You should be measuring how much aggregate capital corporate America is returning to owners measured as a percentage of the current valuation.

Hahaha. Must be nice living in that bubble of yours. Whatever helps you sleep at night.

No matter the scenario - equities collapsing 90%, unemployment exceeding 25%, or inflation running out of control - my family will still be fine.

You know all those posts about financial history aren't just academic, right? The ones where I'm constantly harping on the need to have your affairs in a place where they can survive even unthinkable catastrophic events? Those aren't mindless platitudes; I expect the wise will actually use them to manage their own estate.

I reserve the word "bubble" for a widespread dislocation of the market value of an asset from the underlying justifiable discounted-cash flow intrinsic value for a sustained period of time, as market psychology takes over and people begin to make buy and sell decisions on factors other than what can be extracted from the asset itself and / or a situation in which the current pricing structure lends itself to what must be an inevitable decline based on, but not limited to, historical patterns. The bond market meets the condition at the moment, but the United States as a whole does not. In fact, it doesn't come anywhere close. To assert otherwise requires a very shallow understanding of economics and the monetary supply.

"Unemployment" is already at 14% so what's another 11%? Honestly, how would it matter? What would the tipping point be? Not to mention that many of those new jobs created were burger flippers hence the "fight for 15". Pretty pathetic that they're making less than I was at summer jobs during college and THAT is why everyone is so upbeat to invest their money.

http://money.cnn.com/2013/09/06/news/economy/labor-force-participation/

What do you think happens when you have only 63.2% of the working age population actually contributing towards society. Someone will pay for them. Do you think those 38% are going to be buying health insurance? i don't think so.

I'm confident your family will do fine. If everyone lived like you, we wouldn't have people buying houses they couldn't afford to begin this nonsense. But writing about how rosy you think everything in a country doing so poorly that it has to resort to spend on spying on it's own citizens for fear that they will lash out as terrorists is complete nonsense. Not to mention that we have schoolchildren and college students killing each other almost on a daily basis with no real reform on gun control. All of this while education becomes unaffordable. It's also pretty sad that the biggest stock gains recently come from a company who decided to make the switch to sell users personal information while notifying them after the fact. So much for not being evil.

I'm waiting for the next catastrophic event to do any investing because I still believe everything is artificially inflated There has been no real improvement. In the state I live in you have companies blackmailing for special benefits to keep them from relocating, they get their breaks and then they go on to move their operation or do layoffs anyways. Every single adult I worked with complained almost daily about wanting to move to another state because of how prices on everything are rising.

This country is a joke and it's only going to get worse as the interest starts compounding. You are absolutely correct that there will be corrections. I just wish they'd end this nonsense and get it over with. We should have defaulted because we need significant change in the way the country elects its leaders. Currently our politicians are owned by the corporations that purchase them. It doesn't matter if they wear the red tag or the blue tag.

Your first instinct was to say that your family will be fine. Your family will be fine, but your country certainly will not. Not at this rate. That is more or less the frame of mind of the corporations who buy our elected officials seats. They have essentially separated the government from it's people by allowing money to run the system. The government does not work for the people. It works for the interests of the corporations who are doing everything they can to screw over Americans for their bottomline.

And they are making some DUMB ass decisions with lasting effects like ruining our credit rating etc. Gotta love how that last hissy fit gave everyone a paid 2 week vacation so long as they had the funds to maintain themselves.

Every week I read articles about people working longer into retirement. What happens when the baby boomers finally start dying off or retiring en masse while your millennials who could not afford an education suddenly have to start contributing to their benefits. haha!

I personally refuse to invest until:
1. money is taken out of politics and we are actually being represented by our government
2. education isn't something that only the rich can afford and people are free to pursue what they want with their lives to help contribute to a society that we actually want to be a part of

Enjoy your gains. Im pretty confident they will be shortlived.

Explain this to me. What incentive do these people have for increasing hiring when their pay is tied to the stock market and the Fed will continue to inflate the market for their record salaries?

http://www.bizjournals.com/sanfrancisco/blog/2013/10/apple-facebook-salesforce-zuckerberg.html?ana=RSS&s=article_search&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+bizj_national+%28Bizjournals+National+Feed%29

And how is it seen as an effective strategy when we continue to see articles about the lackluster improvement and job growth SLOWING?

http://www.latimes.com/business/la-fi-jobs-20131023,0,5023001.story

You don't get to be a multimillionaire by living in a bubble, m r.

Plenty of people become multimillionaires by living in bubbles... I think you are forgetting actors, athletes, musicians and heirs. People in America have been conditioned to give too much blind respect to wealth and profit while turning a blind eye to their harmful byproducts.

I have no choice but to concede that you're correct that some people become wealthy despite living in a bubble. I didn't phrase my sentiment quite well, but I'm too busy to reattempt!

Facebook wouldn't have an incentive to hire, regardless. Let's throw out last year's slightly obfuscated numbers and look at 2011, which is a better indication of the economics of the business itself. The firm generated $3.711 billion in sales and $1.756 billion in pre-tax operating profits. There is almost nothing in the history of global commerce that comes close to that. It's keeping $0.47 out of every $1.00 it brings in before paying the tax man. And not only that, it managed to achieve this on $3.53 billion in average shareholder equity for the year.

Those figures are staggering. The company has greater than 90% market share in an industry that it practically invented, along with the now much-reduced MySpace (that's the curse of this particularly lucrative market - the switching costs are low so if management ever ceases to be smart, the profits could go up in smoke).

If the Federal Reserve weren't doing what it is doing, and say stocks were crushed to 50% of their current levels, sure he would have made less money as the option values were lower, but Facebook wouldn't have hired any more employees. That world existed once in the late 19th century, when stocks were expected (and did) yield significantly more than bonds. Facebook would simply go into dividend mode, paying out most of that profit. Instead of options, the CEO would have been given restricted shares that received part of the dividend income, which is actually fairly standard in certain industries if you did through proxy statements. (They're actually called Restricted Stock Units, or RSU's.)

This isn't like the old days of steel mills. Even stable blue chips, like Colgate-Palmolive, have radically fewer employees per million dollars of revenue than would have been necessary even two generations ago. Instead, they have average salaried employees earning $132,000 per year with advanced chemistry degrees. Machines do the rest.

So the plain, non-politically correct, naked truth? That's why the unemployment figures aren't hitting the real economy as much as you would expect given historical experience. If this were 1970, the current unemployment landscape would be devastating. Now? It's barely noticed unless you are on the bottom of the economic bell curve because the value of certain types of jobs have diverged so radically. Back in the Great Recession of 2009, I didn't know a single person in my day-to-day life who was effected or who lost their job. Not one. We are living in two different worlds now, which has some real dangers for the social fabric and cohesion of the nation long-term.*

As horrible as it is to say, in strictly economic terms, 1 Colgate-Palmolive salaried worker is worth 12 or more high-school-only hourly workers. And the unemployment rate for those Colgate-Palmolive-type employees is near historical lows and nearly half of that experienced by the general economy. That's why you see a lot of misery among the low-skill set, but it doesn't seem to be having the expect one would anticipate. The game changed. And when you factor in what we've also discussed - college graduates are much more likely to get married and marry someone with equal educational attainment - the actual households of these people have disproportionate influence on the economy. Thus, a new metric should be invented that weights unemployment and underemployment by the hypothetical value of the human capital of the household to give a better indication of the economic ramifications. There isn't a supercomputer in the world that could pull that off at the moment, but that's the variable that matters. That's what is happening.

* How this gets solved is anyone's guess. A few years ago, I recommended a book by Peter Drucker that talked about this in-depth decades before it happened. He warned us it was coming. He points out that most intelligent, high-skill people are not going to accept transfer payments (read: higher taxes) as they will view it as punishment for the years of hard work and success they put in to becoming a doctor, or executive, or whatever. On the other hand, you might get a French Revolution, which causes even worse economic destruction. If computing power continues to accelerate, it is probable that humanity could see a world in the next 100-200 years where the typical citizen of a rich country could have his or her needs met without a need to constantly work. How is such an economy structured? How are the social fault lines formed? There is no paradigm for it. Humanity went through this during the Industrial Revolution, which shifted the entire foundations of the globe in ways that had never been equalled. This revolution is no less powerful; we're living through it, though, so it can be hard to see it for the trees.

2/3 of the places ive worked at i was working with people who had masters degrees in chemistry in manufacturing who had been laid off from their original jobs in labs no doubt for much less than what they were originally making. rofl.

"He points out that most intelligent, high-skill people are not going to accept transfer payments (read: higher taxes) as they will view it as punishment for the years of hard work and success they put in to becoming a doctor, or executive, or whatever" I have thought about this before and I can easily see this happening after 2014 with the Republicans performance this year.

I answered your question about unemployment in your other comment. A couple of quick notes about this post, though.

1. Why would you refuse to invest? Say that everything you worry about happens. All of it. Devastating. Pain. Calamity. Investing is the process of putting out money today to get more purchasing power (read: net of inflation) in the future, after taxes, adjusted for risk. If your hypothesis turned out to be true, wouldn't the most rational course of action be to acquire, for cash, productive farm land capable of sustaining not only your family, but your community in the event of a mass liquidation or hyperinflation event, depending on how that Janus coin fell? Or, perhaps, buying a cabin in a country with relatively stable finances, such as Canada or Switzerland? I mean, really, if you thought this were a possibility, why don't you have part of your savings shipped overseas and get a nice, inexpensive, lake-side home in the Alps?

2. There are two economic models a society can follow. One is to invest in the young, provide free or low-cost education, training, and skills, and increase the aggregate value of the human capital (from which nearly all sustainable wealth flows; it's what's around long after the oil dries up or the gold is mined). The other is to overtax the young, make them pay their own education, and drain their paychecks through transfer payments to the elderly and disabled, who live off the money. There is a wide sample size of nations that have taken either approach. Somewhere in the middle are the responsible countries who use pay-as-you-go systems that are self-contained (e.g., the Australian retirement scheme).

In any event, unsustainable pensions aren't inevitable. Those unfunded promises? Financial history provides a wide range of illustrations that people will only put up with so much. They benefits will get cut, the municipalities will go bankrupt and the promises shattered in court, or tax rates will rise (and people will flee; look at migration patterns once this course of action is taken). It's that simple. And places that were run intelligently, like the Milwaukee pension system, will do just fine.

The Federal Government is in a much better place. Those $125 trillion or whatever it is in unfunded benefits the Federal Government promised? A couple of votes and they're gone. It's not like private debt. It's an implied promise that can be modified. That's the benefit of sovereignty. Though it would be economically devastating on a macro-level (then again, perhaps not because payroll taxes would cease and working families would have tons more cash per paycheck to spend), Social Security could be gone. It's not a constitutionally guaranteed program.

They'll play the same games in january/febuary that they played last week. Stocks will drop again. 2008-2011 was the time to get in on the game. Isn't it great that they rolled back the insider trading STOCK Act they created during election year months later? Everything is artificially inflated now. They rely on the QE nonsense.

Yeah I wish I had been born in Australia. My friend there is paying next to nothing for his law degree compared to here. Wages are also higher there and food is barely any more expensive as long as you don't eat out a lot. Property seems to be more expensive there though. but otherwise it seems to be a much better place to live.

He.. helped... negotiate.... nuclear.. issues...? I like his style, but still when your job is preventing violence of this magnitude from ever occurring then I think this is where you cross the line with being anonymous.

http://news.yahoo.com/white-house-official-fired-over-anonymous-tweets-034122331.html

Also just found this gem. They really know how to write songs that hit all the right notes in their themes for the "bottom of the bellcurve" as you would say. Really fitting song for our generation with regard to so many different perspectives between immigrants, poor uneducated people, furloughed workers and everyone iin general waiting for reform. So angsty. Sounds great.

http://www.youtube.com/watch?v=RsKQOm_iJug

I just read an article that reminded me of this blog post that I thought you might enjoy on this Christmas eve:

http://www.cracked.com/article_20731_5-amazing-pieces-good-news-nobody-reporting.html?page=full

Incidentally the S&P 500 again reached new highs again yesterday.

Happy Christmas, Joshua and all!