Is there anyone else feeling that we’re long overdue for a day that’s well in the green? Call it wishful thinking, but it seems like investors have to recognize how oversold this market is at some point!
relative to natural gdp growth over the past 200 years, we’re still overvalued by 100% makes you think…
The relationship between stock market growth and GDP growth is influenced by a lot of stuff. Generally stock returns are higher than GDP returns. 1) A lot of the growth in GDP may be in non-traded companies (or at least non-traded equity). If there is a difference between the average growth rates of private and public companies, then that may show up in the GDP vs Stock Market Growth rates. Given that young companies generally grow faster, it suggests that stock market growth should be (at least a bit) slower than total GDP growth. On the other hand, more mature companies tend to be larger, so a larger portion of GDP growth may be from publicly traded companies, so it may not be substantially slower. 2) The main issue is that Stock returns tend to be leveraged returns. GDP growth is basically the ROA figure on all assets in the economy. But the stock market return is basically the ROE on listed company assets. If we assume that listed companies are more or less similar to unlisted companies, or at least the dominant portion of the economy, the main difference between GDP and Stock returns should be the average difference between ROA and ROE. ROE/ROA = Financial Leverage Ratio. It’s difficult to say whether the Financial Leverage Ratio will go down substantially or not. On the one hand, we’re in a deleveraging phase, which would suggest that financial leverage should be dropping. On the other hand, we’ve had a massive equity wipeout, which means that financial leverage has spiked in the short term. This suggests to me that when fundamentals improve, we may get a big but brief equity jump, followed by slow increases because we won’t have all that leverage like we did before.
Great post bchad, remember as well that the returns to capital have been much higher than the returns to labour since the industrial revolution…
fundamentals are based on and forecasted on past information. the fact that currently forecasted fundamentals may still be overly optimistic with equal, if not greater probability than them being overly pessimistic, allows your explanation of relatively increased financial leverage to have the same effect on the downside. leverage works both ways and if fundamentals continue to worsen, then equity will get bashed that much more. in respect to what the fundamental values actually are: just because equity is leveraged due to the existence of debt, doesn’t mean that the total return on equity is supposed to be greater than debt. i am challenging traditional financial thought, but it is a possibility that how we create, trade and view debt, may possibly impede on the returns of equity and they may fundamentally return less than gdp even. and to CFAHalifax… “past evidence often leads to future error” and one final point, the fundamental values derived from gdp which i referred to previously have the historical multiplier already factored in. so with adjustment, the actual values are still far beyond their fundamental values for equity in particular.