Finding the Missing Link Between Stocks and GDP

Summing It Up

If we throw all these measures into the econometric pot, the model improves somewhat, but the late-1990s equity bubble remains in the chart. Let's coin a phrase and call it "irrational exuberance." The good news is the stock market-GDP relationship was at fair value at the end of March 2003; the market's second-quarter rally has no doubt pushed us back into slight overvaluation at this point.

The Bubble Remains

Source: Howard Simons

What will we need to carry us higher? Over the past half-century, we cannot demonstrate stable causal links between total return on stocks and GDP, after-tax profitability, capital expenditures or inflation. All the usual suspects are hereby released on their own recognizance. The best model is the least-satisfying and most-circular one: Stocks will rise so long as people are willing to own them, and nothing more. An orangutan would agree.