From Lex on The Fed

Apologies for the interruption. You may resume buying. The Fed, after saying it might well raise rates, did not.

The steady six-year ascent in the US stock market has been — as anyone will tell you — the product of officially-provided liquidity. The causal link joining Janet Yellen to your retirement account is plain. When the central bank suppresses interest rates, it lowers the discount rate on shares’ future cash flows. Or, for the less technically-minded, it makes bond yields so poor that stocks must be bought. This universally acknowledged truth is proven by the fact that go-go growth stocks have, in particular, soared. When a dollar in 10 years is worth almost as much as a dollar today, why not grab for the piles of future cash a biotech or social media stock promises? So now that Ms Yellen has opted against a quarter-turn of the spigot, the water level can go on rising.

This is a clear, simple explanation of what has happened, and what will. Like most clear, simple explanations of markets, it is not to be depended upon. The relationship between short rates and the discount rate investors apply to long-lived stocks is, to put it mildly, debatable. Further, if fixed income and stock returns were fully fungible in the minds of investors, the yields of the two would maintain a stable long term relationship. They do not.

More fundamentally, there is more to share values than discount rates. There is the level of the cash flows as well. And rosy projections for cash flow growth are under threat, given the sudden turn in the commodity cycle, politico-economic uncertainty in China, and profit growth at US companies grinding slowly to a halt. The decision to keep money loose is an acknowledgement of these economic risks.

Keep on buying…


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