Recently, the AMG team was asked by a client to address a recently published opinion article by Robert J. Samuelson of the Washington Post titled “Has The Next Bubble Arrived?”
The article references the work of Eugene Steuerle of the Urban Institute and his warning “that the economy might be on the edge of a giant ‘wealth bubble’ that will collapse with possibly dire consequences.”
The article indicates that a possible reason for concern about the economy today is that the ratio of household net worth to GDP, which has mostly remained 4:1 or less since 1950, reached 4.5:1 in 2000 (the “tech bubble”), 4.9:1 in 2007 (the “housing bubble”), and 5.3:1 at the end of 2018. The column implies that since the recent level is well above a long-term norm of 4:1, that by itself is evidence of the possibility of a bubble that could lead to a recession and collapse in asset values.
Okay, let’s acknowledge that asset valuations are historically high and that an economic downturn or some other event that causes a hit to confidence could lead to a significant decline in asset values. However, relying on one indicator, such as the household net worth to GDP ratio, is not the best foundation for reaching a broad, and dire, conclusion about general economic conditions.
By way of illustration, let’s conduct a thought experiment. When the aforementioned ratio values occurred, long-term Treasury yields were approximately 5%, 6% and 2.5%, respectively. Presumably, the assets held by households provide a perpetual stream of cash, goods and services. So, we can roughly approximate the present value of that stream by discounting its annual value by the long-term Treasury yield. In that case, the recent annual value of the stream appears to be only about half of what it was in 2000 and 2007. Intuitively, this seems quite unlikely. Alternatively, one could assume that the annual value of the stream has not changed much and argue that long-term Treasury yields are widely expected to rise to around 6.25% in the very near future. That also seems unlikely, but it would cut the value of household net worth by roughly 25% and the household net worth to GDP ratio to 4.0, the purported long-term norm.
In conclusion, AMG recognizes that asset values and household net worth are above historical norms, but in our opinion, probably not so much as to conclude that the economy is on the edge of a “giant wealth bubble”.