The Wall Street bulls embracing sky-high stock values and the Washington pols embracing big deficits may be ideological opposites, but they have something important in common. Both draw sustenance from near-zero interest rates which make stocks more valuable and debt more supportable. And both risk taking this basically sound logic to extremes.
The rally in everything from big tech stocks to
to bitcoin are all manifestations of what Wall Street calls “TINA” for “there is no alternative”: when bank deposits pay nothing and government bonds next to nothing, investors will grasp at almost anything in search of a return.
Directionally, this is not wrong. The value of an asset is its future income, discounted to the present using interest rates, plus a “risk premium”—the extra return you expect for owning something riskier than a government bond. A declining interest rate or risk premium boosts the present value of that future income.
This can certainly justify some of the market’s rally. The ratio of the S&P 500 to expected earnings has jumped from 18 in 2019 to 22 now, lowering the inverse of that ratio, the “earnings yield,” from about 5.5% to 4.6%. That happens to closely track the decline in the 10-year Treasury yield from 1.9% to around 1%. Low rates also help explain the outperformance of big growth companies like
for whom the bulk of profits lie far in the future.
Has this gone too far? In a blog post Aswath Damodaran, a New York University finance professor, worked out the intrinsic value of the S&P 500 assuming bond yields at 2% over the long run and an equity risk premium of 5%. The result: The S&P on Friday was roughly 11% overvalued.
Maybe that’s not bubble territory, but it’s definitely expensive. And while you can justify the overall market level with moderately bullish assumptions, you need ever more contrived arguments as the spotlight moves to individual sectors and stocks.
To justify Apple’s current value, you need a lot of confidence about how the next few years will turn out. To justify Tesla’s, you need a lot of confidence about the next few decades. To justify
—well, has anyone who bought it recently thought beyond the next few days?
The same low-rate logic fueling the everything rally has now found its way into the fiscal debate in Washington. Congress in the last year has borrowed roughly $3.4 trillion to combat the pandemic and its economic fallout, and President Biden has proposed borrowing $1.9 trillion more. These sums would together equal roughly 25% of gross domestic product—the largest burst of national borrowing since World War II.
In advocating for this package, Mr. Biden and Treasury…
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