Asset prices are a measure less of our wealth than of our propensity for self-congratulation. The net effect is only a transfer between the existing owners and the prospective owners.
We greet our neighbours with the hope that they will experience a good morning, a reflection of the days when we lived by agriculture. John Kenneth Galbraith proposed that the equivalent courtesy in the new industrial state was “low price”. Mostly, falling prices are good news. Better news if you are a buyer than if you are a seller. But if you are a seller in a competitive market, lower prices are usually a consequence of falling costs and the lower price expands the market. In computers and consumer electronics, prices have been falling year by year for decades while sales and profits of most producers have steadily increased. Good news all round.
Warren Buffett, the billionaire investor, has argued that asset markets are no different. He pokes fun at volatile Mr Market, who from time to time is willing to sell him goods at prices that are too low. But Mr Buffett’s is a minority view. Financial markets are spooked by the threat of lower house prices and everyone on CNBC is gloomy when the screen is splashed with red.
But, as usual, the Sage of Omaha has a point. Selling ourselves the same goods at higher prices leaves us neither better nor worse off so long as the goods themselves remain the same. For every house seller, there is a house buyer.
Usually the seller is older than the buyer. Typically, people under 45 are still climbing up the housing ladder while those above that age have reached the top or are easing themselves down. House prices are a transfer of income and wealth between generations. The scale of the transfer is very large. In a modern economy, the value of the housing stock is typically three times national income. That means a 10 per cent rise in house prices can represent a redistribution from young to old of 30 per cent of incomes. The potential burden of the past decade’s rise in house prices on young workers dwarfs the potential burden of pensions or medical care for the elderly that cause such general concern.
These full effects would be realised if existing house owners accessed the whole of their increased wealth through equity release. But they do not. The older generation passes on the balance of its wealth to the next. So the pattern of equity release determines how house prices affect consumption. In the short run, home owners spend more; in the medium term, prospective home owners have less to spend on other consumption; in the long run, the legacies arrive.
Just as a house remains a house, the corporation remains the same collection of tangible and intangible assets whatever is happening in the markets. The businesses, fixed assets, skills and capabilities that are General Electric barely change from week to week or even year to year. When bond prices rise, the interest and principal are unchanged; when oil prices soar, the physical stuff in the ground remains the same.
So what is true of houses is also true of other assets, such as stocks and shares. What changes is not their underlying value, but our perception of their value. Asset prices are a measure less of our wealth than of our propensity for self-congratulation. The net effect is only a transfer between the existing owners and the prospective owners.
Stock prices are also a means of intergenerational redistribution. Falling markets are bad news for the old, good news for the young. And although many people have satisfied their housing needs by middle age, they typically go on acquiring assets until they retire. Most people in work should be pleased when markets fall. That does not seem to be how they feel.
The insight that fundamentals remain the same through market fluctuations is the basis of the only mechanical investment rule that has ever been proved to work: pound or dollar cost averaging. Put the same amount of money into the market month by month, year by year, and you end up with a collection of shares bought for less than the average market price. The greater the volatility, the greater the benefit. In troubled times, every cloud has a silver lining.