Never assume the markets are wrong

23rd June 2019 Off By binary
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Here’s the FT:

One can look at equities and bond yields and conclude that one of these markets is very wrong.

Of course markets are always wrong in the sense that each day new information comes in and prices move to new levels reflecting that new inflation. Ex ante, however, there is no reason to assume that the stock and bond markets cannot both be correct. Here’s what I see as the most likely explanation:

1. Long run changes in saving and investment are gradually producing a lower “new normal” of global real interest rates. For any given flow of corporate earnings, that’s bullish for stock prices.

2. Over the past year, expectations regarding economic growth in the US and elsewhere have fallen somewhat. These slower growth expectations have reduced the expected future flow of corporate earnings.

Both factors tend to depress bond yields, whereas factor #1 boosts equity prices while factor #2 depresses equity prices. Taking everything into account, you’d expect bond yields to be much lower than 9 months ago, and you’d expect relatively little change in equity prices. And that’s exactly what has happened.

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