It’s a familiar refrain: The re-rating behind 2023’s US equity rally is incongruous with elevated real rates.
I’m sympathetic to that line of reasoning. If there’s a bear case I buy, it’s that one. Real yields are (or usually are) kryptonite for stocks, and particularly for richly-valued stocks.
Given that, rapid valuation expansion in the face of relentlessly rising reals is counterintuitive to the point of being difficult to countenance. The simple figure below illustrates the point.
In August, rising reals dented equities, but not by enough to matter. The yawning disparity between valuations and reals remains.
On Monday, JPMorgan analysts led by Marko Kolanovic reiterated the point. “Equities are up YTD on multiple expansion while real rates and the cost of capital are moving deeper into restrictive territory,” they wrote. “History suggests this relationship is becoming increasingly unsustainable.”
Kolanovic said the S&P’s multiple is “over-valued by 3-4x” versus reals — specifically, ~2.7x and ~3.9x excluding the post-COVID period and the dot-com bubble.
It’s worth including the figures below, from Nomura’s Charlie McElligott.
“The ERP is 4th%ile relative to post-GFC history, the Fed Model-based valuation is the most expensive since 2002 and is disconnected from a slowing business cycle,” JPMorgan’s strategists went on, adding that other traditional valuation metrics are likewise stretched.
In his Monday missive, Morgan Stanley’s Mike Wilson dryly remarked that the ERP is at a 20-year low with earnings risk at a 20-year high.
The willingness of people to pay up for all kinds of things like cars, houses, delivery services, air fare and the list goes on and on might extend to a subset of stocks as well. we will only know after the fact how long this will continue.
What we might realize, like we have with many other things, that we were getting a “bargain” before and some items are settling on their new higher prices. As I have noted before about the high prices for everything in Vegas. I must now realize that the good old days are never coming back and people see value at the current prices and are willing to pay them. I remember when Def Lepard was a hot act in the mid eighties. Concert tickets for their shows in stadiums and arenas were about $50. in the early 90’s I saw them for free in a Walmart parking lot where they were playing a store opening. They and other acts just like them now play to small but still decent sized venues for $200-300 a pop. People see the value in this. can’t explain it but that’s the way it is.