5 ms·

"as if the fundamentals of asset classes change radically depending on how they are marketed" More like the fundamentals of asset classes change radically depe

"as if the fundamentals of asset classes change radically depending on how they are marketed" More like the fundamentals of asset classes change radically depending on how they're regulated & taxed, who is willing / able to buy them, what the composition of that asset class is, and how much money there is flowing in and out of that asset class. And we're not even really talking about "fundamentals", since there is so much path dependency, especially in the context of drawing-down of those assets to finance retirement. A rise in variance would be bad enough. Stock prices in the long run represent a time-discounted income stream (as do all securities) (plus a bundle of legal rights, which is mostly irrelevant for individuals). It is not mathematically possible to have the stock market growing by 4% and GDP growing by 2% ad infinitum; you would have the value of the stock market exceed the discounted value of all future economic activity. There is a cogent argument that the inflation in stocks has been due to 1) more economic activity falling under the umbrella of publicly traded corporations (private blacksmith displaced by Ford), 2) capital inflows driven by privatized retirement savings, interest rate manipulation, etc. 3) a legal & economic regime that encourages "paper assets" in general. None of those are perpetual forces.

snowwrestler 10y ago
> It is not mathematically possible to have the stock market growing by 4% and GDP growing by 2% ad infinitum; you would have the value of the stock market exceed the discounted value of all future economic activity. The value of future economic activity is perpetually hypothetical, so when would the reckoning arrive?
- h4nkoslo 10y ago
  When the size of the discrepancy exceeds the risk-adjusted cost of arbitrage.
dragonwriter 10y ago
> It is not mathematically possible to have the stock market growing by 4% and GDP growing by 2% ad infinitum Yes, it is. First, because there is no necessary mathematical relationship between the aggregate market cap of firms and economic output (future or otherwise). There are rational expectations that can be stated, but those aren't actual constraints, since irrationality is a real thing. Second, the economic universe from which the stock market draws value is not limited to the domestic economy, so even if there was a constraint based on economic output, it wouldn't be GDP.
- h4nkoslo 10y ago
  "Maybe the future will be perpetually irrational about asset prices" is not really a compelling economic story. There is indeed a mathematical relation between long run asset prices and the income generated by those assets. In the short run you can do whatever you want, but the long run constraint is predictably enforced by arbitrage. (it is left as an exercise to construct the most entertaining arbitrage play in a world where stock prices diverge indefinitely from the value produced by the underlying assets via some magic.)
  - dragonwriter 10y ago
    > "Maybe the future will be perpetually irrational about asset prices" is not really a compelling economic story. Perhaps, but then we are getting into rational expectations and not mathematical constraints. (Though, really, given that rationality requires perfect knowledge of future utilities, "the future will be perpetually irrational about asset prices" is pretty much guaranteed to be true except for intermittent times when it isn't momentarily largely by chance; even a consistent divergence in a particular direction from rationality isn't surprising, given what we the particular ways in which people tend to be deviate from economic rationality in practice.) > There is indeed a mathematical relation between long run asset prices and the income generated by those assets. No, there is a mathematical relation between reasonable asset prices and expected income streams that the assets will generate. > In the short run you can do whatever you want, but the long run constraint is predictably enforced by arbitrage. "In the long run, we're all dead" -- Keynes Even granting your point for the sake of argument, what must ultimately be true in the long run assuming an infinite time horizon need never actually be true in the physical universe we inhabit. Irrationality in prices can be maintained indefinitely, even though not infinitely -- but then, the market can't actually exist infinitely, anyway.
    - smallnamespace 10y ago
      Betting that the market reverts to 'rational' pricing in any short time frame is a risky bet, but I'll claim it's much, much more reasonable than assuming that irrationality persists indefinitely. OTOH, there's another story to why equity returns are higher than GDP returns: equity investors are being compensated for the higher risk.
whack 10y ago
Stock-market-returns are almost always going to be higher than GDP growth, by a significant margin. A GDP growth of X% implies that companies revenues/profits are going to be ~X% higher next year. But your return-on-investment isn't driven purely by the X% profit growth. It's also driven by the baseline profits that companies make. If you buy a share for $10, and it has an EPS of $0.50, you're immediately getting an ROI of 5%, even in a flat-GDP world. If GDP grows by 2%, and the company's projected-future-profits grow by 2%, you'll get the benefit of that 2% profit growth, in addition to the baselines ROI of 5%. The PE ratio gives a pretty good indicator of long-term ROI baseline. Given the current PE ratio of 25, which is certainly worryingly high, it still implies a baseline ROI of 4%. Any GDP growth we happen to get, is simply gravy on top of that baseline.

snowwrestler 10y ago

> It is not mathematically possible to have the stock market growing by 4% and GDP growing by 2% ad infinitum; you would have the value of the stock market exceed the discounted value of all future economic activity. The value of future economic activity is perpetually hypothetical, so when would the reckoning arrive?

h4nkoslo 10y ago
When the size of the discrepancy exceeds the risk-adjusted cost of arbitrage.

dragonwriter 10y ago

> It is not mathematically possible to have the stock market growing by 4% and GDP growing by 2% ad infinitum Yes, it is. First, because there is no necessary mathematical relationship between the aggregate market cap of firms and economic output (future or otherwise). There are rational expectations that can be stated, but those aren't actual constraints, since irrationality is a real thing. Second, the economic universe from which the stock market draws value is not limited to the domestic economy, so even if there was a constraint based on economic output, it wouldn't be GDP.

h4nkoslo 10y ago
"Maybe the future will be perpetually irrational about asset prices" is not really a compelling economic story. There is indeed a mathematical relation between long run asset prices and the income generated by those assets. In the short run you can do whatever you want, but the long run constraint is predictably enforced by arbitrage. (it is left as an exercise to construct the most entertaining arbitrage play in a world where stock prices diverge indefinitely from the value produced by the underlying assets via some magic.)
- dragonwriter 10y ago
  > "Maybe the future will be perpetually irrational about asset prices" is not really a compelling economic story. Perhaps, but then we are getting into rational expectations and not mathematical constraints. (Though, really, given that rationality requires perfect knowledge of future utilities, "the future will be perpetually irrational about asset prices" is pretty much guaranteed to be true except for intermittent times when it isn't momentarily largely by chance; even a consistent divergence in a particular direction from rationality isn't surprising, given what we the particular ways in which people tend to be deviate from economic rationality in practice.) > There is indeed a mathematical relation between long run asset prices and the income generated by those assets. No, there is a mathematical relation between reasonable asset prices and expected income streams that the assets will generate. > In the short run you can do whatever you want, but the long run constraint is predictably enforced by arbitrage. "In the long run, we're all dead" -- Keynes Even granting your point for the sake of argument, what must ultimately be true in the long run assuming an infinite time horizon need never actually be true in the physical universe we inhabit. Irrationality in prices can be maintained indefinitely, even though not infinitely -- but then, the market can't actually exist infinitely, anyway.
  - smallnamespace 10y ago
    Betting that the market reverts to 'rational' pricing in any short time frame is a risky bet, but I'll claim it's much, much more reasonable than assuming that irrationality persists indefinitely. OTOH, there's another story to why equity returns are higher than GDP returns: equity investors are being compensated for the higher risk.

whack 10y ago

Stock-market-returns are almost always going to be higher than GDP growth, by a significant margin. A GDP growth of X% implies that companies revenues/profits are going to be ~X% higher next year. But your return-on-investment isn't driven purely by the X% profit growth. It's also driven by the baseline profits that companies make. If you buy a share for $10, and it has an EPS of $0.50, you're immediately getting an ROI of 5%, even in a flat-GDP world. If GDP grows by 2%, and the company's projected-future-profits grow by 2%, you'll get the benefit of that 2% profit growth, in addition to the baselines ROI of 5%. The PE ratio gives a pretty good indicator of long-term ROI baseline. Given the current PE ratio of 25, which is certainly worryingly high, it still implies a baseline ROI of 4%. Any GDP growth we happen to get, is simply gravy on top of that baseline.