[Insight & Opinion] Do Indicators Really Reveal Whether Housing and Stock Prices Are in a Bubble?

[Asia Economy] While announcing the interest rate hike, Lee Chang-yong, Governor of the Bank of Korea, said that current house prices and stock prices are at high levels. But how high are they if they are high? According to the KB Nationwide Housing Comprehensive Sales Price Index, prices have risen 20% compared to two years ago and 5% compared to one year ago. Is the bubble 20% or 5%? The KOSPI, which has fallen 25% from its peak, how much more does it need to fall? The primary criterion for judging a bubble is profitability. For stocks, it is done by comparing bond yields and dividend yields. Real estate can also have its yield calculated.

The most important factor in the Swiss investment bank UBS’s ‘Global Real Estate Bubble Index’ is the Price To Rent ratio. However, focusing only on current profitability is unrealistic. The Price Income Ratio (PIR) looks at purchasing power. It calculates the ratio of household annual income to the median house price in the country or city. Usually, it is considered that saving income for six years should be enough to buy a median-priced house. There is also the Housing Purchase Burden Index published by the Korea Housing Finance Corporation. It calculates the repayment burden when a median-income household takes out a loan to buy a median-priced house. Changes in interest rates are reflected in purchasing power. Currently, in Seoul, more than 50% of income must be spent on loan repayment, while an appropriate burden is about 25% of income.

A representative indicator for evaluating stock market bubbles is ‘Tobin’s q,’ named after economist James Tobin. It is the ratio of a company’s market value to its asset value. The average over the past 110 years is 0.7. There is also the Price Earnings Ratio (PER), which is the stock price divided by earnings per share. The U.S. Federal Reserve (Fed) prefers a stock market valuation model (FVM) that uses this indicator. It compares the 12-month forward earnings yield (1/PER) of the stock market with the 10-year Treasury yield. There is also the Cyclically Adjusted Price Earnings Ratio (CAPE), created by Yale professor Robert Shiller based on PER. It divides the inflation-adjusted S&P 500 index by the 10-year average earnings per share. The 20-year average is 25.9, and currently, it is 30.1. An easily calculated indicator is the Buffett Valuation Indicator, named after investor Warren Buffett. It represents the ratio of the stock market’s market capitalization to Gross Domestic Product (GDP). If it exceeds 100%, it is considered a bubble. CNN’s Fear & Greed Index combines seven indicators, including the difference between stock earnings yields and government bond yields. It is currently at a neutral level.

There are many indicators, but unfortunately, none of them can be said to be the definitive answer. The Price Earnings Ratio of our stock market, which rose to 15 times, has now fallen below 10 times. The KOSPI’s Buffett Indicator is also below 100%. However, this does not mean that the stock market will only rise from now on. The PIR of apartments in Seoul is over 17 years, but that does not mean prices will soon fall by half.

Bubbles have poor memory. Regardless of indicators, they change records and suddenly burst at some point. We still do not know the size of the bubble or the exact time it will burst. Naturally, Governor Lee Chang-yong does not know either. He can only speculate by comparing with past averages. To readers who read this article to the end hoping for some plausible explanation, I apologize, but there is no sure way to know such things. What we know is that there is a bubble, and the size of the bubble can only be confirmed after it bursts.

Kim Sang-chul, Economic Commentator

This content was produced with the assistance of AI translation services.