Sure, I think about stocks in terms of earnings yield, but it’s not actually equivalent to bond yields, for example, if we’re talking about the typical quote using trailing 12 month earnings.

I impute the forward P/E in market prices when thinking about my approach. That’s different than what you seem to be talking about. I’m not even sure what point you’re trying to make or what the relevance is.

]]>Earnings yield and price express exactly the same thing. They are mathematically equivalent. At any point in time earnings are a constant. For any given earnings yield, there is only one price, and for any given price there is only one earnings yield. If equities were traded on the basis of yield instead of price, you would then be arguing that price is different because it includes earnings yield.

But… it is a mistake to think that they are different or that there is any kind of causal connection between the two. It would be like debating the causal connection between the PE ratio and the earnings yield. They are just different ways of expressing the same thing. Whether people talk about price or about yield is just a convention based on convenience and historical practice.

]]>If you look at countries in western Europe, in addition to Japan, you find mean earnings yields on broad stock indexes that are higher than the mean NGDP growth rates, depsite low long-term real interest rates. That makes sense, given the relatively worse demographic prospects, ceteris paribus.

But, if you’re right about the US having similarly declining real growth prospects, albeit not as bad, why isn’t the mean earnings yield running above the mean NGDP growth rate? Do you think this is a trend yet to come, or do you think factors like pricing power are making the difference? I assume you don’t think changes in pricing power occur within, say, single years to cause stock prices to rise as much as 29%. That would seem silly. Increasing pricing power would be more of a long-run phenomenon, as companies like Apple and Tesla mature.

]]>If you think the earnings yield and the stock price are the same thing, then it supports my view, which is apparently what you meant with your earlier reply. I suspect you mean that the reciprocal of the earnings yield, the P/E ratio and stock price are the same thing. They aren’t, of course, because the earnings yield includes price, but the P/E multiple is an essential feature. And, of course, the P/E is highly correlated with price.

]]>I would think of it this way…. the earnings yield and the stock price are exactly the same thing. They are just two different ways of measuring or saying the same thing. We could just as easily quote stock prices as an earnings yield. I come from a fixed income and options background so this is obvious and innate to me, but I think it’s a less obvious way of thinking about things if you come at it from an equities perspective. ]]>

Yes, your comments seem to indicate you get the gist of it.

To answer your questions:

a.) NGDP growth expectations determine stock prices on the macro level. I think there’s a certain rate of expected NGDP growth each year, for example, and then real and nominal NGDP shocks lead to changes in stock prices. However, for temporary real shocks the influence on stock prices will be minimal if the Fed keeps expected aggregate demand stable. Hence, almost all relatively large stock market price movements are caused by the Fed.

b.) Monopolization is a gradual process at the macro level, so I don’t see it causing abrupt changes to stock prices. Changes in tax policy can obviously cause real shocks with lasting effects on prices. However, I don’t think bracket creep, which has been greatly reduced since the 1970s has much effect on stock prices when inflation is low.

I think real interest rates are a mostly a distraction, whether one is talking about the stance of monetary policy, or factors driving changes in stock prices. Tighter money can lead to lower real rates in the short-term, or higher real rates, depending on the circumstances. It lead to lower real rates after the Great Recession, for example, and higher real rates during the current tightening cycle. In the long-run, real rates are determined by real factors, of course.

I want to emphasize something in this thread that I’ve only implied. The discount rate for the S&P 500 spot price is the earnings yield. In my discussions with economists and finance-types, many have been surprised by that fact, as it seems that they don’t spend much time explicitly playing with the relevant equations.

]]>I think you may be making this unnecessarily complicated by thinking of rates and prices as separate variables. For some assets, we regularly use multiple terms to express the same thing. Price and yield in the case of bonds. Volatility and price in the case of options. Yields and price for commercial real estate. Etc. In the case of equities, it’s less convenient to do this, but fundamentally the equivalence still exists, and if we wanted we could just as easily express equity prices as earnings yields. ]]>

There are certainly companies in the S&P 500 with considerable pricing power. Apple comes to mind, for example. But, I don’t see why or how that’d be a major factor to consider in 2019, in particular.

Sure, the drop in real rates alone could explain much of the stock price increase in 2019, given the standard finance model, but I don’t think that model is sound. Why did real rates fall? That’s the important question. You’ve acknowledged that lower real rates do not always lead to lower stock prices.

]]>I have seen your comments about this before and generally agree. From a logical perspective, it passes the sniff test. Essentially, what you’re saying is that there is a close correlation between corporate earnings, real rates and NGDP growth.

My questions would be: a) which way is causality pointing, and b) what is the impact of exogenous factors (e.g. tax rates on capital, increasing degrees of monopolization, etc.)

I think you’re probably right in the long term, but in the short term, I think relative asset prices are very sensitive to changes in real after tax risk adjusted rates. Or to put it more accurately, I think asset prices react very quickly to changes in relative risk adjusted rates.

]]>You believe raising the target rate is unlikely to get you any additional real growth. I.e. you think any increase above 3% in the NGDP target will translate 100% into nominal growth and 0% real growth.

Given how beneficial real growth is, your reluctance to even consider a higher target suggests you are highly confident that a higher NGDP target will not produce any additional real growth.

Is that a correct interpretation?

Parallel question – If the NGDP target is lowered below 3%, will the long term reduction in growth be a) 100% nominal, b) 100% real, or c) some combination of real and nominal?

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