Friday, March 30, 2007

Real Share Prices

A few months ago, we heard in the news media that many share price indices around the world were at record levels. But were they? A share price index is measured in domestic currency, and is simply a nominal variable. If the index has increased over time, that simply means that the average investor selling their shares today will receive more money than they paid for then. Whether their real wealth has increased is not clear.

Michael Mandel (thanks to Newmark's Door for the pointer) corrects that with a real S&P 500 index, deflating it by the CPI, and shows that the S&P 500 is significantly lower today than it was in 1999.

How about Hong Kong? The HSI has grown from 8,800 during SARS in 2003 to highs of over 20,000 recently. It is 12% higher than its previous peak in 1999.

How about the real value of the HSI? That is also at an all-time peak, and is almost 17% higher than its previous peak, due to the persistent deflation (falls in the CPI) between 1999 and 2004.

The more important question is whether shares in Hong Kong are now too expensive. That's a more difficult question, since the fundamental underlying value of the HSI is the discounted expected future profits of the underlying companies. Hong Kong company profits are, in turn, heavily dependent on the growth rate of Mainland China, and it's anybody's guess as to how fast and for how long China will continue it's remarkable growth path. Hong Kong shares might still be a bargain.... we cannot know for sure.

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