SYNOPSIS: Don't confuse the honest debate over the stock market with insane Policy Entreprenaurs.

It has always been hard to have a rational discussion about the stock market: hope and fear, greed and envy get in the way. And it's even harder nowadays because politics has entered the mix. Not only do some ideologues believe that to love capitalism is to love its stocks, whatever their price; also, the promise of high stock returns serves the same purpose today that the Laffer curve served 20 years ago. That is, it helps politicians -- particularly politicians who want to privatize Social Security -- offer visions of sugar plums, of gain without pain.

Still, there is a real debate about the prospects for stock prices, with serious arguments on both sides.

Last year bulls dominated the public discourse, but we have lately been hearing a lot from the sophisticated bears -- people like Robert Shiller, the author of "Irrational Exuberance," or Andrew Smithers and Stephen Wright, co-authors of "Valuing Wall Street." Their arguments are straightforward: by historical standards, current stock values look way out of line. The price-earnings ratio of the average company is more than twice its historical average; so is "q" -- the ratio of the market value of corporations to the value of their underlying assets. And in the past a high P/E or a high q was usually a portent of capital losses to come. So this is certainly a point of view that should be taken seriously.

But will the future be like the past? Sophisticated bulls -- exemplified by Jeremy Siegel, author of the influential 1993 book "Stocks for the Long Run" -- point out that stocks have historically been a high-yield, low-risk investment. Indeed, stocks were so good an investment that people should have been willing to pay much higher prices than they did. So valuations that look very high by historical standards might represent not the rise of irrational exuberance but the decline of irrational pessimism. And this, too, is a point of view that should be taken seriously.

It's important, however, to recognize the limits of sophisticated bullishness. The long-run rate of return on stocks tends to be about the same as the "earnings yield" -- the price-earnings ratio people usually talk about only upside down. So even if you believe that stocks aren't particularly risky, this only justifies stock prices high enough so that the earnings yield -- and hence the long-run rate of return on stocks -- is no higher than the rate of return on safe assets like bonds. And we are already there (actually a bit beyond). So the views of sophisticated bulls do not justify a belief either that stocks are still greatly undervalued or that today's generously priced stocks will yield investors anything like the rate of return investors got on the undervalued stocks of decades past.

The reason I emphasize this point, of course, is that if you do not understand it you might confuse the sophisticated bulls with those in a third camp -- mad bulls? -- who do hold one or both of these beliefs.

This is a confusion actively encouraged by the mad bulls themselves. For example, the authors of last year's "Dow 36,000" claimed to base their ideas on the work of Professor Siegel. And there is a sense in which this claim is true. But it is the same sense in which a recipe for pineapple-marshmallow-baloney pizza is based on pizza dough. Yes, the dough is a crucial ingredient; but there are other crucial ingredients, and very questionable ingredients at that.

The sophisticated bulls deserve to be taken seriously; so do the sophisticated bears. The mad bulls don't.

But those are fighting words, and the fight won't be fair. I myself have been angrily accused of inconsistency because I have both criticized the mad bulls and said nice things about Professor Siegel. In other words, "Last year you made fun of pineapple-marshmallow-baloney pizza -- but now you say you like pizza after all. Ha! You've changed your position!"

So let me now lay down the pizza principle for stock prices. I like pizza, and so should you -- that is, you should take seriously the view that a stock market that looks grossly overvalued by historical standards isn't. But even if you do like pizza, you don't have to accept the baloney some people want you to swallow.

Originally published in The New York Times, 7.9.00